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Semester One, The First Half
Midterm Study Guide
80
Economics
10/11/2008

Term
 Economics
Definition
 The science of making decisions in the presence of scarce resources.
Term
 Managerial Economics
Definition
 The study of how to direct scarce resources in the way that most effeciently achieves a managerial goal.
Term
 Economic Profits
Definition
 The difference between total revenue and total opportunity cost
Term
 Opportunity Cost
Definition
 The Cost of explicit and implicit resources that are foregone when a decision is made.
Term
 Profits are a Signal Principle
Definition
 Profits signal to resource holders where resources are most highly valued by society.
Term
 Present Value
Definition
 The amount that would have to be invested today at the prevailing interest rate to generate the given future value.
Term
 Present Value Formula
Definition
 PV = FV           (1+i)2
Term
 Principle of Profit Maximization
Definition
 Maximizing Profits Means Maximizing Value of the Firm, Which is the Present Value of Current and Future Profits
Term
 Marginal BenefitMargina Cost
Definition
 The change in total benefits arising from a change in the managerial control value Q.The change in total costs arising from a change in the managerial control variable Q.
Term
 Marginal Principle
Definition
 To maximize net benefits, the manager should increase the managerial control variable to the point where marginal benefits equal marginal costs.  This level of managerial control variable corresponds to the level at which marginal net benefits are zero.
Term
 Net Benefit Equation Marginal Net Benefit Equation
Definition
 N(Q) = B(Q) - C(Q)MNB(Q)=MB(Q) - MC(Q)  MB(Q) = ∆B/∆QMC(Q) = ∆C/∆Q
Term
 Differetiate the foci of Microeconomics vs Macroeconomics
Definition
 Microeconomics is concerned with decision making of individuals, families, groups, firms and government agencies. Macroeconomics is concerned with the movement of the economy as a whole - inflation rates, unemployment levels, money supply and interest rates.
Term
 What are the 3 main economic problems in an economy?
Definition
 what to producehow to produce itfor whom to produce
Term
 What is the most important promise of economics?
Definition
 Efficiency
Term
 Pareto Efficiency
Definition
 State of an economy where no one can be made better off without making someone worse off Depends on Productive Efficiency, Allocative Efficiency, Distributional Efficiency
Term
 Production Possibility Frontier
Definition
 Graph that shows all the combinations of goods and svcs that can be produced if all of society's or a company's or farmer's or individual's resources are used efficiently.
Term
 Why does the PPF bow outward?
Definition
 Increasing marginal opportunity costs when you make more of something else, because you are giving up increasing opportunities to make something else.  Also called declining returns to scale.
Term
 3 Goals of Economics (with respect to PPF)
Definition
 move to the PPF move to right point on the PPF shift PPF out
Term
Definition
 Comparative Advantage - the ability to produce some good or svc at a lower opportunity cost than other producers  Competitive Advantage - ability to produce some good or svc at a lower absolute cost than other producers
Term
 Name the 4 Properties of an Indifference Curve
Definition
 Completeness (consumers know their preferences)More is betterTransitivity (If a>b, and b>c, then a>c)Diminishing marginal rates of substitution
Term
 What are the constraints of producers vs that of consumers?
Definition
 Producers - labor and capital Consumers - budget
Term
 What is the slope of: Budget Line  Indifference Curve
Definition
 Budget is Px/Py Indifference Curve is MUx/MUy Consumer purchases at point where MUx/MUy = Px/Py
Term
 Utility Maximizing Rule:
Definition
 Stop changing consumption when MUx/Px=MUy/Py
Term
 market demand curve
Definition
 curve indicating the total quantity of a good all consumers are willing and able to purchase at each possible price, all other variables constant.
Term
 change in quantity demanded vs change in demand
Definition
 change in quantity demanded caused by change in price and is represented by movement along demand curve change in demand is caused by change in variables other than price and is represented by movement of entire demand curve
Term
 Name 5 demand shifters
Definition
 Income, price of related goods, advertising and consumer tastes, population, consumer expectations.
Term
 Differentiate Normal vs Inferior Good
Definition
 normal good - demand for good increases when income increases and vice versa inferior good - demand for good decreases when income increases and vice versa
Term
 Subsitute Good vs Complementary Good
Definition
 Substitute - goods for which increase in price of one good leads to increase in demand of other good.   Complementary - goods for which increase in price of one good leads to decrease in demand of other good.
Term
Definition
 informative - provides info to consumers about existence or quality of a product persuasive - alters underlying tastes of consumers
Term
 demand function
Definition
 describes how much of a good will be purchased at alternative prices of that good and related goods, alternative income levels, and alternative values of other variables affecting demand Qdx= f(Px, Py, M,H)
Term
 linear demand function
Definition
 linear representation of demand function Qdx= α0+ αxPx+ αyPy+ αMM + αHH
Term
 How do you determine if good Y in demand function is a complement or substitute?
Definition
 if αy>0, y is a substituteif αy<0, y is a complement
Term
 How do you determine if good x is a normal good or an inferior good in the linear demand equation?
Definition
 If αM>0, x is a normal good If αM<0, x is an inferior good
Term
 Consumer Surplus
Definition
 Value consumers get from a good but do not have to pay for. Area above price but below demand curve.
Term
 Market Supply Curve
Definition
 Curve Indicating the total quantity of a good that all producers in a competitive market would produce at  each price, holding input prices, technology, and other variables affecting supply constant.
Term
 Change in quantity supplied vs Change in supply
Definition
 Change in quantity supplied is caused by price and reflects movement along supply curve. Change in supply is caused by non price variable changes and reflect movement of the supply curve.
Term
 Name 6 Supply Shifters
Definition
 Input pricesTechnology/Govt Regulations Number of FirmsSubstitutes in ProductionTaxesProducer Expectations
Term
 Supply Function
Definition
 describes how much of a good will be produced at alternative prices of that good, all other variables constant. Qsx= f(Px,Pr,W,H)
Term
 Linear Supply Function
Definition
 Qsx= βo+ βxPx+ βrPr+ βwW+βHH
Term
 Producer Surplus
Definition
 Amount a producer receives above the amount necessary to induce them to produce a good.   Area above supply curve and below price.
Term
 Principle of Competitive Market Equilibrium
Definition
 Equilibrium in a competitive market is determined by the intersection of the market supply and demand curves
Term
 Full Economic Price
Definition
 Dollar amount paid to afirm under a price ceiling plus the nonpecuniary price.
Term
 Difference in effect of excise tax and ad valorem (percentage) tax on supply curve
Definition
 Excise tax shifts supply curve up (to the L) Ad Valorem tax shifts supply curve counter clockwise - making curve steeper.
Term
 What is the law of downward sloping demand curve
Definition
 At higher prices, consumers demand less.  At lower prices, consumers demand more.
Term
 What are exceptions to downward sloping demand curve law?
Definition
 Prestige goodsGoods with unknown qualityCurrent price used as signal for future prices
Term
 What is basic demand equation?
Definition
 P = a+bQ (a is Y intercept, and b is the slope)
Term
 Elasticity
Definition
 Responsivness of one variable to change in another.  Refers to price unless specified. E = %∆Q/%∆P E>1 = ELASTIC E<1 = INELASTIC E = 1 GOOD IS UNIT ELASTIC
Term
 Solving for elasticities
Definition
 ∆Q/Q /∆P/P = ∆Q/∆P x P/Q
Term
 What is effect of price on revenue of elastic good. Unit Elastic Good. Inelastic Good.
Definition
 1) Revenues fall 2) No effect  3) Revenues rise   note - total revenues are maximized where demand is unitary elastic
Term
 What are 2 neoclassical economic functions of price
Definition
 Signaling Function Rationing Function
Term
 Limitations of price in economics
Definition
 doesn't include externalitiesdoesn't take into account distribution of incomeshort term thinking with resources valuation by future generations
Term
 Comparative Statistics
Definition
 Study of movement from one equilibrium to another.
Term
 For Demand Curve Q=a+bP, what is slope?
Definition
 1/b
Term
 Differentiate:  Own Price ElasticityIncome ElasticityCross Price ElasticitySupply Elasticity
Definition
 1) Responsiveness of quantity demanded to price change.2)" to income change3) " to change in price of another good4) " quantity produced to change in price
Term
 Perfectly Elastic Demand
Definition
 Price elasticity is infinite in absolute value.  If price of good is raised even slightly, none of good is purchased.  Supplier is a price taker. Demand curve is horizontal.
Term
 Perfectly Inelastic Demand
Definition
 Price elasticity is zero.  Demand curve is vertical.
Term
 Name 3 factors that affect price elasticity.
Definition
 Available substitutes Time (inelastic in short term, more elastic in long term) Expenditure Share (Goods that make up small part of consumers' budgets more inelastic than those that make up large part of budget)
Term
 What is formula describing relationship between Marginal Revenue and Elasticity?
Definition
 MR = P [(1+E)/E] MR+ - demand elasticMR 0 - unit elasticMR -  - inelastic
Term
 Cross Price Elasticity Formula
Definition
 EQP= %∆Qdx/%∆Py
Term
 Income Elasticity Formula
Definition
 EQM= %∆Qdx/ %∆M
Term
 GNAW argues that there really is no market supply curve. What is the argument?
Definition
 A market supply curve holds all else constant and simply adjusts price.  Empirically, all else is not constant.
Term
 What does market data on crude oil show?
Definition
 The price of oil fluctuates widely in response to quantity available.  This is due to quantity demanded remaining constant regardless of immediate supply available.
Term
 What is the theory of market adjustment? What do you think of this theory?
Definition
 The theory of market adjustment uses a double auction spot market for sales, all goods are sold at same price.   Market forces will tend to make prices and quantity move toward the equilibrium point.  Surplus usually causes declining prices, shortage - increasing prices.  This is a static model.
Term
 What is dead weight loss? Why should we care about it? Why shouldn't we care about it?
Definition
 Deadweight loss is benefit that is lost both to producer and consumer resulting from taxes, etc.  Value is lost in regards to the specific good that is being taxed, but the 'lost' benefit is transferred to another area of the economy, such as the city or a stop smoking campaign...
Term
 What is the difference between short run and long run elasticities? Can you give an example of each for elasticity of demand or elasticity of supply?
Definition
 Short run elasticity measures nearly immediate responsiveness to price change. Long run elasticity measures response to a price change after economic actors have had time to make adjustments.  Elasticity of demand - higher oil prices, people switch to fuel efficient cars. Elasticity of supply - trans fat cookies - cookie makers elminated ingredient from cookies.
Term
 When does the seller have more power: when he or she faces an inelastic demand curve or an elastic demand curve? Why?
Definition
 Seller has more power when demand curve is inelastic.  Price stays higher.
Term
 Why, specifically, might a firm want to know the price elaticity for its products?
Definition
 So that it can plan for pricing strategies.
Term
 Why are textbooks often so expensive?
Definition
 Demand is inelastic.
Term
 Define Marginal Rate of Substitution
Definition
 The rate at which a consumer is willing to substitute one good for another good and still maintain the same level of satisfaction
Term
 Indifference Curve
Definition
 Curve that defines the combinations of two or more goods that give a consumer the same level of satisfaction.
Term
 Budget Set
Definition
 Bundles of goods consumer can afford PxX + PyY ≤M
Term
 Budget Line
Definition
 Bundles of goods that exhaust a consumer's income. PxX + PyY =M  Properties of Budget Line:  Slope is -Px/PyHorizontal Intercept = M/PxVertical Intercept = M/Py
Term
 Market Rate of Substitution
Definition
 Rate at which one good may be traded for another in the market.   Slope of the budget line ( -Px/Py)
Term
 Consumer Equilibrium
Definition
 Equilibrium Consumption Bundle Is affordable Bundle that yields greatest satisfaction to the consumer. For consumer equilibrium, marginal rate of substitution (MRS) = Px/Py
Term
 What effect does price change have on demand curve?
Definition
 Demand curve shifts clockwise or counterclockwise, becoming more steep or flat.
Term
 Substitution Effect
Definition
 Movement along indifference curve resulting from a change in the price of goods.
Term
 Incomce Effect
Definition
 Movement from one indifference to another that results from the change in real income caused by a price change.
Term
 Buy one get one free deals have what effect on budget line?
Definition
 Budget line becomes horizontal between Q1 and Q2, then resumes slope.
Term
 Diminishing marginal rate of substitution
Definition
 As a consumer gets more of a certain good, they are willing to substitute less of another good for more of the original good.
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