ECON 101 Final Review: Consumer Choice, Market Equilibrium, Welfare and Market Power

Terms in this set (30)

1. What is opportunity cost?The value of the next best alternative given up when a choice is made. Example: the opportunity cost of a year in school includes the wages you could have earned working.
2. Movement along a demand curve vs a shift of the curveA change in the good's own price causes a movement along the curve (change in quantity demanded). A change in any other factor shifts the whole curve (change in demand).
3. List the main factors that shift a demand curve.Consumer income, prices of related goods (substitutes and complements), tastes, expectations about future prices or income, and the number of buyers.
4. Normal good vs inferior goodDemand for a normal good rises when income rises; demand for an inferior good falls when income rises (e.g., instant noodles or bus travel for some consumers).
5. How does cross-price elasticity identify substitutes and complements?Cross-price elasticity = %ΔQ of good A / %ΔP of good B. Positive means substitutes (coffee and tea); negative means complements (printers and ink).
6. Price elasticity of demand using the midpoint methodE = (ΔQ / average Q) / (ΔP / average P). If |E| > 1 demand is elastic, if |E| < 1 inelastic, and if |E| = 1 unit elastic.
7. Mini-problem: price rises from $4 to $6 and quantity falls from 120 to 80. Find the midpoint elasticity.%ΔQ = −40/100 = −0.4 and %ΔP = 2/5 = 0.4, so E = −1. Demand is unit elastic over this range and total revenue stays the same ($480).
8. If demand is elastic, what happens to total revenue when price rises?Total revenue falls, because the percentage drop in quantity is larger than the percentage rise in price. With inelastic demand, a price rise increases total revenue.
9. Define consumer surplus and producer surplus.Consumer surplus is willingness to pay minus price paid (area below demand, above price). Producer surplus is price received minus marginal cost (area above supply, below price).
10. Supply and demand both increase. What happens to equilibrium price and quantity?Quantity definitely rises, but the price change is ambiguous: it depends on which curve shifts by more.
11. What happens with a binding price ceiling?Set below equilibrium, it creates a shortage (quantity demanded exceeds quantity supplied), lowers the quantity traded and causes a deadweight loss. Rent control is a classic example.
12. Who bears more of the burden of a per-unit tax?The side of the market that is less elastic. Tax incidence does not depend on whether the government collects the tax from buyers or from sellers.
13. What is deadweight loss?The loss of total surplus when the quantity traded differs from the efficient quantity, for example due to taxes, price controls, monopoly or externalities.
14. State the consumer's optimal choice condition for two goods.Spend the budget so that MUx / Px = MUy / Py. Graphically, the indifference curve is tangent to the budget line: MRS = Px / Py.
15. What is the slope of the budget line, and how does an income increase change it?With good X on the horizontal axis, the slope is −Px / Py. An increase in income shifts the line outward in parallel; a price change rotates it.
16. Substitution effect vs income effect of a price decreaseSubstitution effect: the good is now relatively cheaper, so you buy more of it. Income effect: your purchasing power rises, which raises consumption of normal goods and lowers it for inferior goods.
17. What is the law of diminishing marginal returns?In the short run, as more of a variable input (like labour) is added to a fixed input (like capital), the extra output from each additional unit eventually falls.
18. Where does marginal cost cross the average cost curves?The MC curve crosses both the average variable cost and average total cost curves at their minimum points.
19. Economic profit vs accounting profitAccounting profit = revenue − explicit costs. Economic profit = revenue − explicit costs − implicit (opportunity) costs. Zero economic profit means the firm earns a normal return.
20. Profit-maximizing rule and short-run shutdown rule for a perfectly competitive firmProduce where P = MC. In the short run, shut down if price is below the minimum of average variable cost.
21. What is long-run equilibrium in a perfectly competitive industry?Free entry and exit push price to the minimum of average total cost, so firms earn zero economic profit and P = MC = min ATC.
22. Why is marginal revenue less than price for a monopolist?To sell one more unit, a single-price monopolist must lower the price on all units, so the extra revenue is less than the price of the extra unit.
23. Mini-problem: a monopolist faces P = 100 − 2Q with MC = 20. Find Q and P.MR = 100 − 4Q. Set MR = MC: 100 − 4Q = 20, so Q = 20. Price comes from demand: P = 100 − 2(20) = 60.
24. Compare monopoly and perfect competition outcomes.A monopoly produces less and charges more (P > MC), creating a deadweight loss. Perfect competition produces where P = MC, which is allocatively efficient.
25. What is perfect (first-degree) price discrimination?Charging each buyer their maximum willingness to pay. The firm captures all consumer surplus and, unusually, produces the efficient quantity, so there is no deadweight loss.
26. What is a dominant strategy?A strategy that gives a player a better payoff than the alternatives no matter what the other players do.
27. Define a Nash equilibrium.A set of strategies where no player can improve their payoff by changing their own strategy, given the strategies of the others.
28. How does the prisoner's dilemma explain why cartels are unstable?Each firm's dominant strategy is to cheat (produce more), even though both would earn more by cooperating. The Nash equilibrium is mutual cheating, which is worse for both.
29. Negative externality and the Pigouvian taxA negative externality is a cost imposed on third parties (e.g., pollution), so the market overproduces. A per-unit tax equal to the marginal external cost moves output to the socially efficient level.
30. What does Pareto efficiency mean?An allocation where no one can be made better off without making someone else worse off. A competitive equilibrium without market failures is Pareto efficient.

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