Midterm 3 Review PDF

Midterm 3 Review Topics Covered Ch. 16/17 Ch. 10/11/12 Monopolistic Externalities Competition Coase theorem Oligopoly Public goods Market comparisons Asymmetric Regulation of information monopolies...

Midterm 3 Review Topics Covered Ch. 16/17 Ch. 10/11/12 Monopolistic Externalities Competition Coase theorem Oligopoly Public goods Market comparisons Asymmetric Regulation of information monopolies Government failures Topics Covered Ch. 23 Ch. 24 GDP CPI Real vs. nominal GDP CPI vs. GDP deflator GDP Deflator Real and nominal interest rates Topics Covered Ch. 28 Ch. 29 Unemployment rate Functions of money Types of Tools of the central unemployment bank Money multiplier Chapter 16/17 Monopolistic Competition 0 profit in the long run Price > min of ATC Product differentiation Oligopoly Few firms in the market No free entry/exit Two options Collude/form a cartel ○ If oligopolies collude, they look the same as a monopoly in p, q, and DWL Price war ○ If they have a price floor, they look the same as perfect competition in p, q, and DWL Market Structure Comparisons Perfect competition Monopolistic competition Free entry/exit Free entry/exit Many buyers/sellers Many buyers/sellers Homogeneous products Product differentiation Market Structure Comparisons Oligopoly No specific graph for an oligopoly, but remember ○ If colluding, same DWL, P, Q, and welfare as monopoly graph ○ If price war, same DWL, P, Q, and welfare as perfect competition Also, a little tip… If a market has FREE ENTRY/ EXIT there will always be 0 PROFIT IN THE LONG Monopoly RUN Barriers to entry Perfect competition One seller Monopolistic competition  Average cost pricing Marginal cost pricing Monopoly Regulation Chapters 10/11/12 Externality Graphs Practice Which of the following would not be considered a negative externality? A. You have an adverse reaction to a medicine your doctor prescribed you B. A factory produces steel and pollution C. Your friend buys a new puppy that barks every night D. Your neighbor mows his lawn early in the morning while you are trying to sleep Practice Which of the following would not be considered a negative externality? A. You have an adverse reaction to a medicine your doctor prescribed you B. A factory produces steel and pollution C. Your friend buys a new puppy that barks every night D. Your neighbor mows his lawn early in the morning while you are trying to sleep Regulation Options Government regulation Pigouvian taxes/subsidies ○ Government sets the price Cap and trade ○ Government sets the quantity Practice In the presence of positive externalities, efficiency can be improved relative to market outcomes by using ________; in the presence of negative externalities, this can be done by using _________. A. Taxes; subsidies B. Taxes; complementary goods C. Mandates; tradable permits D. Mandates; subsidies E. Price ceilings; subsidies F. Price ceilings; complementary goods Practice In the presence of positive externalities, efficiency can be improved relative to market outcomes by using ________; in the presence of negative externalities, this can be done by using _________. A. Taxes; subsidies B. Taxes; complementary goods C. Mandates; tradable permits D. Mandates; subsidies E. Price ceilings; subsidies F. Price ceilings; complementary goods Coase Bargaining Some requirements ○ Low transaction costs ○ Few parties involved ○ Property rights are well defined Optimal outcome will always be reached Party with property rights will never have to pay Practice Suppose that Company A's railroad cars pass through Farmer B's corn fields. The railroad causes an externality to the farmer because the railroad cars emit sparks that cause $1,500 in damage to the farmer's crops. There is a special soy-based grease that the railroad could purchase that would eliminate the damaging sparks. The grease costs $1,300. Suppose that the railroad is not liable for any damage caused to the crops. Assume that there are no transaction costs. Which of the following characterizes the efficient outcome? A. The railroad will purchase the grease for $1300 and pay the farmer nothing because no crop damage will occur B. The farmer will pay the railroad $1300 to purchase the grease so that no crop damage will occur C. The railroad will continue to operate but pay the farmer $1500 in damages D. The farmer will incur $1500 in damages to his crops Practice Suppose that Company A's railroad cars pass through Farmer B's corn fields. The railroad causes an externality to the farmer because the railroad cars emit sparks that cause $1,500 in damage to the farmer's crops. There is a special soy-based grease that the railroad could purchase that would eliminate the damaging sparks. The grease costs $1,300. Suppose that the railroad is not liable for any damage caused to the crops. Assume that there are no transaction costs. Which of the following characterizes the efficient outcome? A. The railroad will purchase the grease for $1300 and pay the farmer nothing because no crop damage will occur B. The farmer will pay the railroad $1300 to purchase the grease so that no crop damage will occur C. The railroad will continue to operate but pay the farmer $1500 in damages D. The farmer will incur $1500 in damages to his crops Types of Goods Public Goods/Inefficiencies Non-rival ○ Marginal cost is 0 ○ Firms will never produce the efficient quantity Non-excludable ○ Free riders ○ Firms cannot estimate true demand for their product Practice A good that is non-rival is inefficiently provided by the free market because A. Demand will be too great for existing firms B. The marginal value of the good exceeds people’s contribution to the good C. Consumption of the good creates a positive externality for others D. The market will have too few firms to be competitive Practice A good that is non-rival is inefficiently provided by the free market because A. Demand will be too great for existing firms B. The marginal value of the good exceeds people’s contribution to the good C. Consumption of the good creates a positive externality for others D. The market will have too few firms to be competitive Asymmetric Information Deals with a mismatch of information between buyers and sellers Moral Hazard ○ Hidden action ○ You change your behavior because you don’t bear the full cost of your actions Adverse Selection ○ Hidden characteristic ○ Buyers/sellers don’t know all relevant information about the other Practice Which of the following is an example of moral hazard? A. A company pays all travel expenses, but allows the employee to choose all travel employments regardless of cost B. An all-you-can-eat buffet realizes some customers are hungrier than others but cannot distinguish them C. A person’s offensive bumper sticker annoys others on the road D. A movie theater concession stand charges well above marginal cost because they are the only source of popcorn in the theater Practice Which of the following is an example of moral hazard? A. A company pays all travel expenses, but allows the employee to choose all travel employments regardless of cost B. An all-you-can-eat buffet realizes some customers are hungrier than others but cannot distinguish them C. A person’s offensive bumper sticker annoys others on the road D. A movie theater concession stand charges well above marginal cost because they are the only source of popcorn in the theater Government Failures Restriction on choice ○ Government restricts the options of individuals Rent seeking ○ Lobbying or campaigning for a specific outcome Bureaucracy ○ Inability to achieve certain outcomes because of red tape Limited information ○ Government does not know all relevant information about an issue Practice Even after a large shift in public opinion, such as against health care reform in the 2010 election, the newly elected officials may not be able to shift policy nearly as much, due to voting rules in the Senate, presidential vetoes, etc. This would be an example of government failure due to A. Restriction on choice B. Rent-seeking C. Bureaucracy D. Limited information Practice Even after a large shift in public opinion, such as against health care reform in the 2010 election, the newly elected officials may not be able to shift policy nearly as much, due to voting rules in the Senate, presidential vetoes, etc. This would be an example of government failure due to A. Restriction on choice B. Rent-seeking C. Bureaucracy D. Limited information Chapter 23 GDP Definition and Components GDP: The market value of all final goods and services produced within a country in a given period of time GDP = C + I + G + NX Practice A U.S. citizen buys a cell phone manufactured in China by a company that is owned and operated by U.S citizens. In which of the following components of U.S. GDP is this transaction accounted for? A. Imports but not consumption B. Consumption and imports C. Consumption but not imports D. Neither consumption nor imports Practice A U.S. citizen buys a cell phone manufactured in China by a company that is owned and operated by U.S citizens. In which of the following components of U.S. GDP is this transaction accounted for? A. Imports but not consumption B. Consumption and imports C. Consumption but not imports D. Neither consumption nor imports GDP Equations Nominal GDP = (Price1 x Quantity1) + (Price2 x Quantity2)... ○ Use prices from that year Real GDP = (Price1 x Quantity1) + (Price2 x Quantity2)... ○ Use prices from the base year GDP Deflator = (Nominal GDP/Real GDP) x 100 Practice Year Webcams Q Webcams P Seminars Q Seminars P 2019 30 $50 50 $500 2020 120 $60 40 $400 Suppose 2019 is the base year. How do we calculate real and nominal GDP for 2020? GDP and Well-Being Higher GDP tends to lead to ○ Better healthcare ○ Better educational systems ○ Longer lifespan But it’s not perfect! GDP excludes ○ Value of leisure ○ Value of domestic labor Chapter 24 CPI Definition: The cost of a basket of goods and services relative to the cost of the same basket in the base year CPI = (Ct /C0) * 100 ○ The cost of the basket is NOT the CPI!!! Inflation Rate = ((CPI2 - CPI1)/CPI1) * 100 Practice Year Cereal Milk 2017 $3.50 $3.50 2018 $3.00 $4.00 Suppose a typical consumer’s basket consists of 20 boxes of cereal and 12 gallons of milk. Prices are given in the table. If 2018 is the base year, then the CPI for 2017 was… How would we find the inflation rate? CPI Biases Introduction of new goods ○ New goods that become part of a typical consumer’s spending, but haven’t yet entered the CPI basket Unmeasured quality change ○ The quality of a good becomes better or worse Substitution bias ○ Some goods in the basket become more expensive, so consumers substitute towards other goods Discount shopping bias ○ The CPI doesn’t take discount shopping into account Practice Suppose OPEC succeeds in raising world oil prices by 300 percent. This price increase causes inventors to look at alternative sources of fuel for internal-combustion engines. A hydrogen-powered engine is developed which is cheaper to operate than gasoline engines. Which problems in the construction of the CPI does this situation represent? A. Substitution bias and unmeasured quality change B. Substitution bias and introduction of new goods C. Introduction of new goods and unmeasured quality change D. Income bias and substitution bias Practice Suppose OPEC succeeds in raising world oil prices by 300 percent. This price increase causes inventors to look at alternative sources of fuel for internal-combustion engines. A hydrogen-powered engine is developed which is cheaper to operate than gasoline engines. Which problems in the construction of the CPI does this situation represent? A. Substitution bias and unmeasured quality change B. Substitution bias and introduction of new goods C. Introduction of new goods and unmeasured quality change D. Income bias and substitution bias CPI vs. GDP Deflator Both are measures of the price level in an economy Usually move together, but with a few differences ○ GDP deflator measures all goods produced, CPI only measures goods consumed ○ CPI includes imports, while imports don’t affect GDP Practice Suppose you observe that the CPI has fallen while the GDP deflator has risen. Which of the following situations can explain these observations? A. The price of capital equipment is falling while the prices of imported goods are falling B. The price of capital equipment is falling while the prices of imported goods are rising C. The price of capital equipment is rising while the prices of imported goods are falling D. The price of capital equipment is rising while the prices of imported goods are rising Practice Suppose you observe that the CPI has fallen while the GDP deflator has risen. Which of the following situations can explain these observations? A. The price of capital equipment is falling while the prices of imported goods are falling B. The price of capital equipment is falling while the prices of imported goods are rising C. The price of capital equipment is rising while the prices of imported goods are falling D. The price of capital equipment is rising while the prices of imported goods are rising Real and Nominal Interest Rates Real interest rate = Nominal interest rate - Inflation Practice Suppose that the real interest rate last year was 5% and the inflation rate was 3%. Thus, during that year, the nominal return from savings was ____, and the purchasing power from savings grew at _____. A. 8%, 2% B. 5%, 2% C. 5%, 8% D. 8%, 5% Practice Suppose that the real interest rate last year was 5% and the inflation rate was 3%. Thus, during that year, the nominal return from savings was ____, and the purchasing power from savings grew at _____. A. 8%, 2% B. 5%, 2% C. 5%, 8% D. 8%, 5% Chapter 28 Unemployment Rate/Labor Force Participation Rate Unemployment rate = u/(e + u) Labor force participation rate = (e + u)/(e + u + n) Labor Force = # of employed people + # of unemployed people Unemployed people = People who are not working but are actively looking for work Not in the labor force = anyone not working and not actively looking for a job Practice Suppose that a well-respected study published in Child Psychology Today finds that a very high proportion of children raised by stay-at-home fathers are accepted to Harvard University. If a large number of previously working fathers quit their jobs and become stay-at-home dads, which of the following will occur, all else equal? A. The unemployment rate will decrease B. The labor force participation rate will decrease C. The number of unemployed people will increase D. A&B E. B&C F. A&C G. All of the above Practice Suppose that a well-respected study published in Child Psychology Today finds that a very high proportion of children raised by stay-at-home fathers are accepted to Harvard University. If a large number of previously working fathers quit their jobs and become stay-at-home dads, which of the following will occur, all else equal? A. The unemployment rate will decrease B. The labor force participation rate will decrease C. The number of unemployed people will increase D. A&B E. B&C F. A&C G. All of the above Types of Unemployment Frictional unemployment ○ Results from taking longer to find a job because you want one that suits your abilities Structural unemployment ○ Occurs anytime the market is prevented from reaching its natural equilibrium Efficiency wages Minimum wage Unions Practice Policies to reduce structural unemployment will always result in A. Workers finding better matches for their skills B. Preventing the shut down of dying industries C. A lower market wage D. Reduction of union influence Practice Policies to reduce structural unemployment will always result in A. Workers finding better matches for their skills B. Preventing the shut down of dying industries C. A lower market wage D. Reduction of union influence Chapter 29 Functions of Money Store of value ○ Money maintains value over time Unit of account ○ Money can be used to compare prices Medium of exchange ○ Money can be used as payment Practice Which of the following details from the Nephite money system best illustrates the “unit of account” function of money? A. Zeezrom offered to trade 6 ontis for Amulek to give a false testimony B. Mormon explained that 6 ontis is several weeks wages for a lawyer C. Change for ontis could be given in smaller denominations of ezroms, amnors, or senums D. People in Mormon’s time would “hide up their treasures in the earth” Practice Which of the following details from the Nephite money system best illustrates the “unit of account” function of money? A. Zeezrom offered to trade 6 ontis for Amulek to give a false testimony B. Mormon explained that 6 ontis is several weeks wages for a lawyer C. Change for ontis could be given in smaller denominations of ezroms, amnors, or senums D. People in Mormon’s time would “hide up their treasures in the earth” Tools of the Central Bank Buying/selling bonds ○ Buying - increase ms ○ Selling - decrease ms Reserve requirement ○ Lower - increase ms ○ Raise - decrease ms Discount rate ○ Lower - increase ms ○ Raise - decrease ms Practice Which of the following actions will decrease the money supply? A. The Fed increases the discount rate B. The Fed raises the reserve requirement C. The Fed sells bonds D. A&B E. A&C F. B&C G. All of the above H. None of the above Practice Which of the following actions will decrease the money supply? A. The Fed increases the discount rate B. The Fed raises the reserve requirement C. The Fed sells bonds D. A&B E. A&C F. B&C G. All of the above H. None of the above Money Multiplier Money multiplier = (1/rr) ○ The amount that money put into or taken out of the economy is multiplied MS = mm * $ ○ The change in money supply when money is put in or taken out Practice If the reserve ratio is 33% for all banks and the federal reserve sells $30 million worth of bonds, then the money supply will A. Increase by $ 90 million B. Increase by $45 million C. Increase by $10 million D. Decrease by $90 million E. Decrease by $45 million F. Decrease by $10 million G. None of the above