ECON 202 Exam Review: Supply and Demand, Elasticity, Costs and Market Structures

Terms in this set (30)

1. Define opportunity cost.The value of the next best alternative given up when making a choice.
2. What does a production possibilities frontier show?The maximum combinations of two goods an economy can produce with its resources and technology. Points inside are inefficient; points outside are unattainable; a bowed-out shape reflects increasing opportunity cost.
3. Absolute vs comparative advantageAbsolute advantage: producing more with the same resources. Comparative advantage: producing at a lower opportunity cost. Gains from trade come from comparative advantage.
4. Change in quantity demanded vs change in demandA change in the good's own price moves along the demand curve (quantity demanded). Changes in income, tastes, related prices, expectations or number of buyers shift the whole curve (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 complementsIf the price of a substitute rises, demand for the good increases. If the price of a complement rises, demand for the good decreases.
7. Supply increases and demand stays the same. What happens to equilibrium price and quantity?Price falls and quantity rises.
8. What is consumer surplus and producer surplus?Consumer surplus: buyers' willingness to pay minus the price paid (area below demand, above price). Producer surplus: price received minus sellers' cost (area above supply, below price).
9. Effect of a binding price ceilingSet below equilibrium, it causes a shortage (quantity demanded > quantity supplied) and deadweight loss. Example: rent control.
10. Effect of a binding price floorSet above equilibrium, it causes a surplus (quantity supplied > quantity demanded). Example: a minimum wage above the market wage can create unemployment.
11. Price elasticity of demand formula (midpoint method)Ed = (% change in Qd) / (% change in P), using percentage changes computed from the average of the starting and ending values. |Ed| > 1 elastic, < 1 inelastic, = 1 unit elastic.
12. If demand is inelastic and price rises, what happens to total revenue?Total revenue increases, because quantity falls by a smaller percentage than price rises.
13. What determines price elasticity of demand?Availability of substitutes, whether the good is a necessity or luxury, share of budget, how narrowly the market is defined, and time horizon (more elastic in the long run).
14. Who bears more of the burden of a tax?The side of the market that is less elastic (less able to adjust) bears more of the tax, regardless of who legally pays it.
15. What is deadweight loss?The loss of total surplus from transactions that no longer occur because of a market distortion such as a tax, price control or monopoly.
16. State the law of diminishing marginal returns.As more of a variable input is added to a fixed input, the additional output from each extra unit eventually decreases.
17. Fixed vs variable costsFixed costs do not change with output in the short run (rent). Variable costs change with output (materials, hourly labor). Total cost = FC + VC.
18. How are marginal cost and average total cost related?MC crosses ATC at the minimum of ATC. When MC < ATC, ATC is falling; when MC > ATC, ATC is rising.
19. Profit-maximizing rule for any firmProduce the quantity where marginal revenue equals marginal cost (MR = MC).
20. When should a perfectly competitive firm shut down in the short run?When price falls below minimum average variable cost (P < AVC).
21. Long-run outcome in perfect competitionFree entry and exit drive economic profit to zero; firms produce at minimum ATC and P = MC = min ATC.
22. Accounting profit vs economic profitAccounting profit = revenue - explicit costs. Economic profit = revenue - explicit costs - implicit costs (opportunity costs). Zero economic profit means a normal return.
23. How does a monopoly differ from perfect competition in price and output?A monopolist faces downward-sloping demand, so MR < P; it sets MR = MC, producing less and charging more than a competitive market, creating deadweight loss.
24. Key features of monopolistic competitionMany firms, differentiated products, free entry. Firms have some price-setting power in the short run, but in the long run economic profit tends to zero.
25. What is an oligopoly and why is game theory useful for it?A market with a few interdependent firms. Each firm's best choice depends on rivals' choices, which game theory models.
26. Explain the prisoners' dilemma.Each player has a dominant strategy to defect, so both defect, even though both would be better off if both cooperated. This explains why cartels are unstable.
27. What is a Nash equilibrium?A set of strategies where no player can improve their payoff by changing strategy alone, given the others' strategies.
28. Negative externality and its market outcomeA cost imposed on third parties (pollution). The market overproduces because private cost is below social cost. A corrective (Pigouvian) tax can fix it.
29. Public goods: what two properties define them?Non-rival (one person's use does not reduce another's) and non-excludable (people cannot easily be prevented from using it), leading to the free-rider problem.
30. What is a government failure?When a policy intervention reduces efficiency or creates new problems, for example from poor information, special-interest lobbying or unintended consequences.