ECON 1 Midterm Review: Trade, Supply and Demand, Elasticity, Welfare and Costs of Production

Terms in this set (32)

1. What is opportunity cost?The value of the next best alternative you give up when making a choice. For example, the opportunity cost of college includes forgone wages, not just tuition.
2. What does it mean to think at the margin?Rational decision-makers compare the marginal benefit and marginal cost of one more unit of an activity and keep going as long as marginal benefit is at least marginal cost.
3. Production possibilities frontier: what do the curve's shape and points mean?The PPF shows the maximum output combinations given resources and technology. Points inside are inefficient, points outside are unattainable. Its bowed-out shape reflects increasing opportunity cost; growth shifts it outward.
4. Absolute vs comparative advantageAbsolute advantage: producing a good using fewer inputs than another producer. Comparative advantage: producing a good at a lower opportunity cost. Gains from trade depend on comparative advantage.
5. Mini-problem: In an hour Ana makes 4 shirts or 2 hats; Ben makes 3 shirts or 3 hats. Who has comparative advantage in hats?Ben. Ana's opportunity cost of 1 hat is 2 shirts; Ben's is 1 shirt. Ana has comparative advantage in shirts (1/2 hat per shirt vs Ben's 1 hat per shirt).
6. For trade to benefit both parties, where must the price (terms of trade) fall?Between the two producers' opportunity costs of the good. For example, if hats cost Ben 1 shirt and Ana 2 shirts, a price between 1 and 2 shirts per hat benefits both.
7. Change in quantity demanded vs change in demandA change in the good's own price causes a movement along the demand curve (change in quantity demanded). A change in any other determinant shifts the entire demand curve (change in demand).
8. What shifts the demand curve?Income, prices of related goods (substitutes and complements), tastes, expectations about the future, and the number of buyers.
9. Normal vs inferior goodsFor a normal good, demand rises when income rises. For an inferior good (such as bus rides or instant noodles for many people), demand falls when income rises.
10. Substitutes vs complementsSubstitutes: a rise in the price of one increases demand for the other (coffee and tea). Complements: a rise in the price of one decreases demand for the other (cars and gasoline).
11. What shifts the supply curve?Input prices, technology, expectations about the future, and the number of sellers. A cost increase shifts supply left; a technology improvement shifts it right.
12. What happens when price is above or below equilibrium?Above equilibrium, quantity supplied exceeds quantity demanded (surplus), pushing price down. Below, quantity demanded exceeds quantity supplied (shortage), pushing price up.
13. If supply and demand both increase, what happens to equilibrium price and quantity?Equilibrium quantity rises. The price change is ambiguous: it rises if demand shifts more than supply and falls if supply shifts more.
14. Price elasticity of demand using the midpoint methodElasticity = (percent change in Qd)/(percent change in P), where percent change = (new − old)/average of the two values. Report the absolute value.
15. How does total revenue respond to a price increase when demand is elastic vs inelastic?Elastic (elasticity > 1): total revenue falls when price rises. Inelastic (< 1): total revenue rises. Unit elastic (= 1): total revenue unchanged.
16. What makes demand more price elastic?Close substitutes available, the good is a luxury rather than a necessity, the market is narrowly defined, and a longer time horizon to adjust.
17. Interpret the signs of income elasticity and cross-price elasticity.Income elasticity > 0 means a normal good, < 0 an inferior good. Cross-price elasticity > 0 means substitutes, < 0 means complements.
18. What does a binding price ceiling do? Give an example.A legal maximum price set below equilibrium creates a shortage (Qd > Qs), possibly with waiting lines, lower quality or black markets. Rent control is a classic example.
19. What does a binding price floor do? Give an example.A legal minimum price set above equilibrium creates a surplus (Qs > Qd). A minimum wage above the equilibrium wage can create unemployment, especially among less-skilled workers.
20. Who bears the burden of a tax?The side of the market that is less elastic bears more of the burden, regardless of whether the tax is legally collected from buyers or sellers.
21. Define consumer surplus and producer surplus.Consumer surplus is buyers' willingness to pay minus the price paid (area below demand, above price). Producer surplus is price received minus sellers' cost (area above supply, below price).
22. Mini-problem: Demand is P = 10 − Q and the price is 4. What is consumer surplus?At P = 4, Q = 6. Consumer surplus = 1/2 × 6 × (10 − 4) = 18.
23. What is deadweight loss from a tax, and how does it scale?The lost total surplus from trades that no longer happen because the tax drives a wedge between buyer and seller prices. It is larger with more elastic supply or demand and grows with the square of the tax: doubling a tax roughly quadruples DWL.
24. When a country opens to trade and the world price is below its domestic price, who gains and who loses?The country imports. Domestic consumers gain, domestic producers lose, and total surplus rises because consumers' gains exceed producers' losses.
25. What does a tariff on imports do?It raises the domestic price, increasing domestic production and reducing imports and consumption. Producers and the government gain, consumers lose more, so a deadweight loss results.
26. Negative externality: market outcome and a standard fixWhen production imposes uncompensated costs on others (like pollution), the market produces more than the socially optimal quantity. A Pigovian tax equal to the external cost per unit can correct it.
27. State the Coase theorem.If private parties can bargain at negligible cost, they can reach an efficient outcome on externalities on their own, regardless of the initial allocation of property rights.
28. Public goods vs common resourcesPublic goods are nonexcludable and nonrival (national defense), leading to free riding and underprovision. Common resources are rival but nonexcludable (ocean fish), leading to overuse, the tragedy of the commons.
29. Accounting profit vs economic profitAccounting profit = revenue − explicit costs. Economic profit = revenue − explicit costs − implicit costs (opportunity costs such as the owner's forgone wages), so it is usually smaller.
30. Why does the marginal cost curve cross average total cost at its minimum?When MC is below ATC, each extra unit pulls the average down; when MC is above ATC, it pulls the average up. So ATC is at its lowest exactly where MC = ATC.
31. How are total, fixed, variable and average costs related?TC = FC + VC. ATC = TC/Q = AFC + AVC. Fixed costs do not vary with output in the short run; AFC falls steadily as Q rises.
32. What is diminishing marginal product?As more of a variable input (like workers) is added to a fixed input (like a factory), each additional unit eventually adds less output. This makes marginal cost rise as output increases.

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