Ashley Stockton CSUMB MICROECONOMICS Fall 2009 Weis McGrath, Ph.D.

STUDY QUESTIONS/ISSUES FOR MIDTERM EXAM

1. a. Use the production possibility frontier (PPF) to discuss the concepts of scarcity, choice, and opportunity cost. b. What would it mean to be inside, outside or on the PPF? Anything inside the production possibility frontier is inefficient because you are not using all the resources available. Outside the PPF is not possible and the economy would need to grow in order to make it possible. On the PPF is efficient. c. What would shift the curve outwards? The curve would shift outward is better resources were available. 2. Know the difference between positive and normative economics Positive economics consist of analysis that tries to answer the questions about the way the world works which have definite right or wrong answers. While normative economics analysis how the world should work. 3. Demand and Supply issues: a. Explain the determinants of demand Change in the price of related goods or services, change in income, change in tastes, change in expectations, and change in number of consumers. b. Explain the determinants of supply. Changes in input prices, changes in the price of related goods or services, changes in technology, changes in expectations, and changes in the number of producers. c. Explain what we mean by equilibrium in the market. Equilibrium is the point where the demand and supply curve cross. d. Assume that we are faced by a disequilibrium in a market (price is higher or lower), how would market forces react? Both forces would move towards equilibrium. e. What would be the outcome if we had a government-instituted price floor or ceiling? If the price floor is above the equilibrium than a surplus is created. If the price ceiling is below the equilibrium than there is a shortage.

f. Be sure to know the difference between a change in Demand (Supply) and a change in the quantity demanded (supplied) Demand is the relationship between quantity demanded and price of production while quantity demanded is one point on the demand curve (the amount consumers are willing to but at one specific price). 4. Be able to explain price ceilings and price floors and some of the advantages and disadvantages associated with them. Price Ceilings- are a force of price control which is when the government intervenes in order to regulate prices. A price ceiling is an upper limit on prices usually imposed by the government during a crisis such as, war, harvest failure, or natural disaster. These crisis could cause a sudden increase in price that will hurt most people while only helping a few. Disadvantages to price ceilings- a persistent shortage of the good, inefficiency rising from this persistent shortage in the form of inefficiently low quantity (deadweight loss), inefficient allocation of the good to consumers, resources wasted in searching for the good, and the inefficiently low quality of the good offered for sale, the emergence of illegal back market activity. Advantages to price ceilings- They protect a few people from being over charged and give a few cheaper prices than they would get in an unregulated market. Price floors- price floors are also a force of price control which is when the government intervenes in order to regulate prices. A price floor is a lower limit on prices. Disadvantages to price floors- a persistent surplus of the good, inefficiency arising from this persistent surplus in the form of inefficiently low quantity (deadweight loss), inefficient allocation of sales among sellers, wasted resources, and an inefficiently high level of quality offered by suppliers, the temptation to engage in illegal activity, particularly bribery and corruption of government officials. Advantages to price floors- benefit some influential sellers of the product. 5. Be prepared to explain and graph a decrease/increase in demand or supply as well as a change in quantity demanded/supplied.

6. a. Explain what we mean by the price elasticity of demand Price elasticity of demand compare the percent change in quantity demanded to the percent change in price as we move along the demand curve.

b. Discuss the determinants of price elasticities of demand Whether the object is a luxury or a necessity, luxury items are more elastic and would lose profit quickly if a major price increase occurred while necessities such as gas would lose profit slowly due to the need for gas and the time needed for consumers to find alternatives. c. Who is interested in the price elasticity of demand and why Producers because it can help predict whether a price change of a certain degree would raise or lower profits. 7. Discuss what happens to total revenue if we have a price increase on a good with inelastic demand versus with elastic demand. The total revenue will increase on a good if the price increases with inelastic demand and the total revenue will decrease on a good if the price increases with elastic demand. 8. Discuss what happens to total revenue if we have a price decrease on a good with inelastic demand versus with elastic demand. The total revenue will decrease on a good if the price decreases with inelastic demand and the total revenue will increase on a good if the price decreases with elastic demand. 9. Explain what we mean by the income elasticity of demand. Differentiate between normal and inferior goods Income elasticity of demand = % change in quantity % change in income Inferior goods are goods which are the things that are used when you cannot afford the normal more preferred goods. As income increases the purchase of inferior goods decreases. As income increases the purchase of normal goods increases. 10. Explain what we mean by the cross-elasticity of demand. Differentiate between substitutes and complements. The cross-elasticity of demand is the ratio of the percent change in quantity demand of one good to the percent change in the price of the other. Substitutes are goods which in some way serve a similar function to the original good. If a product increases in price than its substitutes will increase in demand making substitutes positive. Complements are usually goods which in some way are consumed together. Therefore and increase in the price of one will cause a decrease in the demand of the other. 11. Discuss what we mean by the price elasticity of Supply. What are two factors that determine whether a good is price elastic or inelastic? How quickly producers can respond to price changes. The two factors which determine whether a good is price elastic or inelastic are the availability of inputs and time. Short term- inelastic Long term- elastic

12. Be prepared to draw budget lines if given spending patterns and income (you will differentiate between changes in price and changes in income).

13 a. Explain consumer and producer surplus. Consumer surplus= what you were willing to pay-what you actually paid Producer surplus= what producers are willing and able to supply a good for-the price they actually receive b. When would consumer surplus increase/decrease Consumer surplus would increase when there is a decrease in price and decrease when prices increase. c. When would producer surplus increase/decrease Producer surplus will increase when there is an increase in price and decrease when there is a decrease in price. 14. a. Discuss tax fairness versus tax efficiency Tax fairness uses a progressive tax structure; those who have less pay less. While tax efficiency uses a regressive tax, you pay for what you use. b. What is the difference between progressive, regressive and flat rate taxes and give an example of, each. Progressive tax- takes a large share of the income of high-income tax payers than of lowincome tax payers. Regressive tax-takes a smaller share of the income of high-income tax payers than of low-income tax payers. Flat taxes- everyone pays the same regardless of income. 15. a. Discuss the major benefits of international trade.

Every country benefits from international trade. This trade allows both countries to obtain more of a product than they would have strictly through their own means. b. who loses and who gains from international trade? Domestic producers/input competing producers lose from international trade while consumers gain. c. what are trade barriers (give examples)? Tariffs and quotas d. who gets hurt and helped by trade barriers and why? Consumer exporters and importers get hurt by trade barriers because there is less variety and competition, meaning higher prices and poor quality. Competing producers get helped by trade barriers because there is less competition therefore they will make more money and can charge higher prices. e. how does trade effect consumer and producer surplus? Trade gives consumer more options at cheaper price so it generally increase there surplus while decreasing producer surplus. 16. Discuss the difference between explicit and implicit costs Explicit cost are the actual cost in dollar amount while implicit cost are the opportunity cost of what you could have potentially made from and alternative. 17. Discuss what we mean by average cost, marginal cost and total cost and how to derive each. Average Cost= Total cost, Marginal Cost= Change in total cost Quantity Change in Quantity Total Cost= fixed cost + variable cost 18. How do consumers maximize their utility? Consumers maximize there utility by purchasing items that when happiness is subtracted by dollar amount it will be the highest positive number possible. Higher than if they had chosen to purchase something different. 19. Explain what we mean by a budget constraints. What determines a budget constraint? Budget constraint requires that the cost of a consumers consumption bundle b no more than the consumers income. This is determined by how high or low of an income the consumer has. 20. Imagine a situation in which there is a device that can help improve productivity in any enterprise by as much as one thousand times. Assume that this device could be operated by anyone. Would this device eliminate scarcity? Discuss. No it would not because regardless of how productive the product is there is still a scarce source of raw materials that are needed in the creation of the product.

21. Name and explain the factors of production. Also be prepared to classify items according to category (land, labor, etc.) Land- location (rent) Labor- workers (wages) Capital- machines, factory, tools, etc.(rate) Entrepreneur- risk taker/person with the idea (profit) 22. Discuss issues related to the circular flow. For example, what does it symbolize? What are choices made by households and firms that determine what, how, and for whom goods and services are produced? Some issues related with circular flow includes that in the real world the distinction between households and firms is unclear, many of the sales firms make are not to households but to other firms, and the figure doesnt show the government which diverts and injects money. Circular flow symbolizes transactions that occur in the economy by flows around a circle. Households purchase goods and services from firms generating money flow to the firms and a flow of goods and services to the households. The money flows back to households as firms purchase factors of production from the household in factor markets. 23. Explain how economists measure a firms cost of production and profit versus how an accountant would. An accountant would just measure the cost in tangible value (dollar amount) while the economist would also add in the opportunity loss. 24. Explain the relationship between a firms output and labor employed in the short run. A firm produces goods and service and hires members of the household. 25. Explain how knowledge of microeconomic principles can help you to be successful as an entrepreneur of manager of a corporation. Knowing how the economy works would help in being an entrepreneur because you will be more equipped to predict and deal with a problems that may arise. You will also be able to maximize your profit and minimize losses.