ECO101 Exam Review: Market Equilibrium, Elasticity, Welfare, Costs and Market Power

Terms in this set (31)

1. Positive vs normative statementsA positive statement describes how the economy works and can be tested ("a higher minimum wage reduces teen employment"). A normative statement is a value judgment about what ought to be ("the minimum wage should be raised").
2. What is the marginal principle, and why should sunk costs be ignored?Do an activity up to the point where marginal benefit equals marginal cost. Sunk costs cannot be recovered whatever you choose, so they should not affect forward-looking decisions.
3. Demand is Qd = 100 - 2P and supply is Qs = -20 + 2P. Find the equilibrium.Set 100 - 2P = -20 + 2P, so 4P = 120 and P = 30. Then Q = 100 - 60 = 40.
4. With Qd = 100 - 2P and Qs = -20 + 2P, find consumer and producer surplus at equilibrium (P = 30, Q = 40).The demand choke price is 50 and the supply intercept price is 10. CS = 0.5 x 40 x (50 - 30) = 400. PS = 0.5 x 40 x (30 - 10) = 400.
5. In the same market (Qd = 100 - 2P, Qs = -20 + 2P), a $4 per-unit tax is placed on sellers. Find the new outcome.Supply becomes Qs = -20 + 2(P - 4). Setting 100 - 2P = -28 + 2P gives P = 32 and Q = 36. Buyers pay $32 and sellers keep $28, so the burden is split equally. Revenue = 4 x 36 = 144. DWL = 0.5 x 4 x 4 = 8.
6. How does price elasticity change along a straight-line demand curve?Demand is elastic on the upper (high-price) part, unit elastic at the midpoint and inelastic on the lower part. Slope is constant, but elasticity is not.
7. Perfectly inelastic vs perfectly elastic demandPerfectly inelastic (elasticity 0): vertical curve; quantity does not respond to price. Perfectly elastic (infinite elasticity): horizontal curve; any price rise drops quantity to zero, as for a single competitive firm's demand.
8. Income rises 10% and the quantity demanded of a good falls 5%. What is the income elasticity, and what kind of good is it?Income elasticity = -5%/10% = -0.5. A negative value means it is an inferior good.
9. The price of good B rises 20% and the quantity demanded of good A rises 10%. Find the cross-price elasticity and the relationship.Cross-price elasticity = 10%/20% = +0.5. A positive value means A and B are substitutes.
10. What makes supply more price elastic?More time to adjust, spare production capacity, inputs that are easy to obtain, and goods that can be stored. Supply is usually more elastic in the long run.
11. Why is a competitive market equilibrium efficient?At the equilibrium quantity, the marginal benefit to buyers (demand) equals the marginal cost to sellers (supply), so total surplus is maximized. Producing more or less creates deadweight loss.
12. What are the effects of an import quota?It limits imports, raising the domestic price and lowering consumer surplus. Domestic producers gain. Whoever holds the import licences collects quota rents, and there is deadweight loss from inefficient domestic production and lost consumption.
13. Effects of a tariff on a small open economyThe domestic price rises by the tariff. Domestic production rises, consumption and imports fall, and the government collects tariff revenue. There are two deadweight loss triangles: one from production and one from consumption.
14. Budget constraint: equation and slopePx·X + Py·Y = I. Plotted with Y on the vertical axis, the slope is -Px/Py. A change in income shifts the line in parallel; a change in one price rotates it.
15. What is the consumer's optimum with indifference curves?The point where an indifference curve is tangent to the budget line: MRS = MUx/MUy = Px/Py. The rate at which the consumer is willing to trade goods equals the rate the market allows.
16. Substitution effect vs income effect of a price decreaseSubstitution effect: the good is now relatively cheaper, so people buy more of it. Income effect: purchasing power rises, which increases quantity for a normal good and decreases it for an inferior good.
17. Marginal product vs average product of labourMPL = ΔQ/ΔL, the extra output from one more worker. APL = Q/L. When MPL is above APL, the average rises; when MPL is below APL, the average falls.
18. TFC = $100, TVC = $200 and Q = 10. Find AFC, AVC and ATC.AFC = 100/10 = $10. AVC = 200/10 = $20. ATC = 300/10 = $30, which also equals AFC + AVC.
19. Economies vs diseconomies of scaleEconomies of scale: long-run average cost falls as output rises (from specialization or spreading large fixed costs). Diseconomies: LRAC rises at very large sizes (coordination problems). Minimum efficient scale is where LRAC first reaches its lowest level.
20. What is a perfectly competitive firm's short-run supply curve?Its marginal cost curve above the minimum of average variable cost. Below that price the firm shuts down and produces nothing.
21. A perfectly competitive industry faces a permanent increase in demand. What happens in the long run?In the short run, price rises and firms earn economic profit. That profit attracts entry, which shifts industry supply right until price falls back to minimum ATC (in a constant-cost industry) and profit returns to zero.
22. A monopolist faces P = 100 - Q with MC = 20. Find Q, P and the deadweight loss.MR = 100 - 2Q. Setting MR = MC gives Q = 40 and P = 60. A competitive market would produce Q = 80, where P = MC. DWL = 0.5 x (60 - 20) x (80 - 40) = 800.
23. What are common barriers to entry that sustain a monopoly?Control of a key resource, government protection (patents, licences), economies of scale large enough to create a natural monopoly, network effects, and high startup costs.
24. Why is regulating a natural monopoly at P = MC a problem, and what is the alternative?For a natural monopoly ATC is falling, so MC is below ATC and pricing at MC causes losses that require a subsidy. Average-cost pricing (P = ATC) lets the firm break even at the cost of some inefficiency.
25. What happens under perfect (first-degree) price discrimination?Each buyer pays their maximum willingness to pay. Output reaches the efficient level, so there is no deadweight loss, but the firm captures all the surplus and consumer surplus is zero.
26. What is a dominant strategy, and how does it differ from a Nash equilibrium?A dominant strategy is a player's best choice whatever the others do. A Nash equilibrium is a set of strategies in which no player can do better by changing their own strategy alone. If every player has a dominant strategy, those strategies form a Nash equilibrium.
27. Why are cartels hard to sustain?Each member gains by secretly producing more than its quota at the high cartel price, so cheating is individually rational. That is a prisoner's dilemma. Cartels are also illegal under competition law in Canada and many other countries.
28. What does the Coase theorem say?If property rights are clearly defined and bargaining costs are low, private parties can negotiate an efficient outcome to an externality, whoever is initially given the right.
29. Positive externality: market outcome and policy fixWhen there are external benefits, such as vaccination or education, social benefit exceeds private benefit, so the market underproduces. A subsidy equal to the marginal external benefit can raise output to the efficient level.
30. What is the tragedy of the commons?Common resources are rival but non-excludable, so each user ignores the cost their use imposes on others, leading to overuse (for example overfishing). Fixes include quotas, tradable permits and property rights.
31. How many workers does a competitive firm hire?Labour demand is derived from output demand. The firm hires until the marginal revenue product of labour, MRPL = MPL x P, equals the wage.