ECON 102 Exam Review: Supply and Demand, Elasticity, Costs and Market Structures

Terms in this set (29)

1. Opportunity costThe value of the next best alternative you give up when making a choice.
2. Comparative vs absolute advantageAbsolute advantage: producing more with the same resources. Comparative advantage: producing at a lower opportunity cost. Trade gains come from comparative advantage.
3. What does a production possibilities frontier show?The maximum combinations of two goods an economy can produce with its resources. Points inside are inefficient, points outside are unattainable, and a bowed-out shape reflects increasing opportunity cost.
4. Change in quantity demanded vs change in demandA change in the good's own price moves along the demand curve (change in quantity demanded). A change in income, tastes, related prices, expectations or number of buyers shifts the whole curve (change in demand).
5. Normal vs inferior goodsDemand for a normal good rises when income rises. Demand for an inferior good falls when income rises.
6. Substitutes vs complementsSubstitutes: a price rise in one raises demand for the other (coffee and tea). Complements: a price rise in one lowers demand for the other (cars and gasoline).
7. If supply increases and demand stays the same, what happens to equilibrium?Equilibrium price falls and equilibrium quantity rises.
8. Price elasticity of demand formulaEd = (% change in quantity demanded) / (% change in price), usually reported as an absolute value. Above 1 is elastic, below 1 is inelastic, exactly 1 is unit elastic.
9. Elasticity and total revenueIf demand is elastic, a price cut raises total revenue. If demand is inelastic, a price increase raises total revenue. At unit elasticity revenue is maximized.
10. What makes demand more elastic?Many close substitutes, a large share of the budget, the good being a luxury, a narrowly defined market, and a longer time horizon.
11. Consumer surplus vs producer surplusConsumer surplus is willingness to pay minus the price paid (area below demand, above price). Producer surplus is the price received minus the cost to sell (area above supply, below price).
12. Effect of a binding price ceilingSet below equilibrium, it causes a shortage (quantity demanded exceeds quantity supplied) and deadweight loss. Rent control is the classic example.
13. Effect of a binding price floorSet above equilibrium, it causes a surplus (quantity supplied exceeds quantity demanded). A minimum wage above the market wage is the classic example.
14. Who bears more of a tax burden?The side of the market that is less elastic bears more of the tax, no matter who legally pays it.
15. What is deadweight loss?The loss of total surplus from trades that would have benefited buyers and sellers but no longer happen, e.g. because of a tax, price control or monopoly.
16. Negative externality and its fixA cost imposed on third parties (pollution), causing overproduction compared with the social optimum. A Pigouvian tax equal to the external cost can correct it.
17. Public good characteristicsNonrival (one person's use does not reduce another's) and nonexcludable (people cannot be kept from using it). Leads to the free-rider problem; example: national defense.
18. Marginal utility and the utility-maximizing ruleMarginal utility is the extra satisfaction from one more unit. Consumers maximize utility when MU_x/P_x = MU_y/P_y.
19. Fixed vs variable costsFixed costs do not change with output in the short run (rent). Variable costs rise with output (materials, hourly labor). TC = FC + VC.
20. Formulas for ATC, AVC and MCATC = TC/Q, AVC = VC/Q, MC = change in TC / change in Q. MC crosses ATC and AVC at their minimum points.
21. Law of diminishing marginal returnsIn the short run, adding more of a variable input to a fixed input eventually makes each additional unit of input add less output.
22. Profit-maximizing rule for any firmProduce the quantity where marginal revenue equals marginal cost (MR = MC).
23. Short-run shutdown rule for a competitive firmShut down if price falls below minimum average variable cost (P < AVC). Between AVC and ATC the firm operates at a loss to cover part of fixed cost.
24. Long-run equilibrium in perfect competitionFree entry and exit drive economic profit to zero, so P = MC = minimum ATC.
25. Accounting profit vs economic profitAccounting profit = revenue - explicit costs. Economic profit = revenue - explicit costs - implicit costs (opportunity costs).
26. How does a monopoly differ from perfect competition?A monopoly faces downward-sloping demand, so MR < P. It sets MR = MC, charges a price above MC, produces less and creates deadweight loss.
27. Monopolistic competition in the long runMany firms sell differentiated products. Entry pushes economic profit to zero, but P > MC and firms produce with excess capacity (not at minimum ATC).
28. Oligopoly and the prisoner's dilemmaFew interdependent firms. Each firm's dominant strategy may be to cheat on collusion, so they end up at a worse outcome for both than if they cooperated.
29. Nash equilibriumA set of strategies where no player can do better by changing their own strategy, given what the others are doing.

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