ECON 1B03 Exam Review: Supply and Demand, Elasticity, Efficiency and Market Structures

Terms in this set (27)

1. What is opportunity cost?The value of the next best alternative given up when making a choice. For example, the opportunity cost of attending class is what you would have earned working those hours.
2. Absolute vs comparative advantageAbsolute advantage: producing more output with the same resources. Comparative advantage: producing at a lower opportunity cost. Gains from trade come from comparative advantage.
3. Mini-problem: A can make 10 shirts or 5 hats per hour; B can make 4 shirts or 4 hats. Who has the comparative advantage in hats?A's cost of 1 hat = 2 shirts; B's cost of 1 hat = 1 shirt. B has the lower opportunity cost, so B has the comparative advantage in hats and A in shirts.
4. What does a bowed-out (concave) production possibilities frontier indicate?Increasing opportunity cost: resources are not equally suited to both goods, so producing more of one good requires giving up increasing amounts of the other.
5. Change in quantity demanded vs change in demandA change in the good's own price moves along the demand curve (change in quantity demanded). Changes in income, tastes, related prices, expectations or number of buyers shift the whole curve (change in demand).
6. Normal vs inferior goodsDemand for a normal good rises when income rises; demand for an inferior good falls when income rises (e.g. instant noodles).
7. 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 (printers and ink).
8. Effect on equilibrium: supply increases while demand is unchangedEquilibrium price falls and equilibrium quantity rises.
9. If supply and demand both increase, what happens to price and quantity?Quantity definitely rises; the effect on price is ambiguous and depends on which shift is larger.
10. Formula for price elasticity of demand (midpoint method)Ed = (% change in Qd)/(% change in P), where each % change = change/average of old and new values. Usually reported as an absolute value.
11. Elastic vs inelastic demand and total revenueIf |Ed| > 1 (elastic), a price cut raises total revenue. If |Ed| < 1 (inelastic), a price cut lowers total revenue. At |Ed| = 1, revenue is maximized.
12. Determinants of price elasticity of demandMore substitutes, a larger share of the budget, a longer time horizon and luxury status make demand more elastic; necessities with few substitutes are inelastic.
13. What does a negative cross-price elasticity indicate?The goods are complements. A positive cross-price elasticity indicates substitutes.
14. Consumer surplus and producer surplusConsumer surplus is willingness to pay minus price (area below demand, above price). Producer surplus is price minus marginal cost (area above supply, below price).
15. Effect of a binding price ceiling (e.g. rent control)Set below equilibrium, it creates a shortage (Qd > Qs), reduces quantity traded and causes deadweight loss, along with waiting lines or black markets.
16. Effect of a binding price floor (e.g. a minimum wage above equilibrium)Set above equilibrium, it creates a surplus (Qs > Qd); in the labour market this surplus is unemployment.
17. Who bears more of a tax burden?The side of the market that is more inelastic bears more of the tax, regardless of whether the tax is legally imposed on buyers or sellers.
18. What is deadweight loss?The loss of total surplus from trades that would have been mutually beneficial but no longer occur, e.g. because of a tax, price control or monopoly.
19. Negative externality and the efficient outcomeWhen production imposes external costs (pollution), the market overproduces because marginal social cost exceeds marginal private cost. A Pigouvian tax equal to the external cost restores efficiency.
20. Public good: two defining featuresNonrival (one person's use does not reduce another's) and nonexcludable (people cannot easily be prevented from using it), which creates a free-rider problem.
21. Accounting profit vs economic profitAccounting profit = revenue - explicit costs. Economic profit = revenue - explicit costs - implicit (opportunity) costs. Zero economic profit still means a normal return.
22. What is the profit-maximizing rule for any firm?Produce where marginal revenue equals marginal cost (MR = MC).
23. When should a perfectly competitive firm shut down in the short run?When price is below minimum average variable cost (P < AVC), because revenue does not even cover variable costs.
24. Long-run equilibrium in perfect competitionEntry and exit drive economic profit to zero, so P = MC = minimum ATC; the market is both allocatively and productively efficient.
25. Why is a monopolist's marginal revenue below price?To sell an extra unit it must lower the price on all units sold (single-price monopoly), so MR < P and the MR curve lies below the demand curve.
26. Monopoly outcome compared with perfect competitionA monopoly produces less output at a higher price (where MR = MC and P > MC), creating deadweight loss.
27. Prisoner's dilemma in oligopolyEach firm has a dominant strategy to cheat (e.g. cut price), so both end up worse off than if they had cooperated; this explains why cartels tend to be unstable.