Microeconomics

Question 1

What is the difference between microeconomics and macroeconomics?

Answer 1

Micro = study of individuals’ and households’ allocation of resources to maximize satisfaction

Macro = study of communities and aggregate entities’ allocation of resources to maximize the common good

Question 2

What are the different questions answered by different economic systems?

Answer 2

(1) what is produced
(2) how much is produced
(3) how goods are produced
(4) who uses production

Question 3

What are the three general kinds of economic systems?

Answer 3

(1) capitalism = no gov’t restrictions on individual activity; all “economic questions” answered by these free markets
(2) communism = gov’t plans almost all economic activity with only limited individual input; all questions answered by gov’t planning
(3) socialism = mixture of (1) and (2), with both private ownership and gov’t intervention; questions answered by gov’t planning and free markets

Question 4

What is demand?

Answer 4

The measure of how much consumers, in aggregate, are willing and able to buy a given good at a given price

Question 5

How are the price of a good and the quantity demanded related?

Answer 5

Inversely

Question 6

What is the cross elasticity of demand?

Answer 6

The sense in which the demand of various goods can affect the demand of other closely related goods

Can be substitutes (where goods’ demand is inversely related) or complements (where it is directly related)

Question 7

As regards the cross elasticity of demand, what are examples of substitutes and complements?

Answer 7

Substitutes: Pepsi and Coke; Toyota and Honda cars
Complements: toothbrush and toothpaste; cars and gasoline

Question 8

What does it mean to say that substitute goods have a positive cross elasticity of demand?

Answer 8

It is positive, because the DEMAND for a good rises as the PRICE for substitute goods increases

Conversely, complementary goods have a negative cross elasticity of demand

Question 9

What is the difference between normal goods and inferior goods?

Answer 9

As income increases, demand for normal goods increases, but demand for inferior goods decreases

As people have more money to spend, they do not want to settle for subpar (inferior) products

Question 10

How do consumer expectations of changing prices affect demand?

Answer 10

If the price is expected to increase, then current demand increases, since customers will be less willing to buy it in the future than in the present

The converse is true for expectations of lower prices

Question 11

What does a demand curve generally look like?

Answer 11

With price on the y-axis and quantity demanded on the x-axis, a demand curve is a line (or curve) with a negative slope

Question 12

What is the difference between an increase in quantity demanded and an increase in demand itself?

Answer 12

The former is a movement along the demand curve; the latter is a movement OF the demand curve itself

With the line in one place, an increase in quantity demanded occurs only as the price decreases – but an increase in demand itself (e.g. if the population’s income rises) would push the entire line to the right

Question 13

What are some examples of events that increase demand?

Answer 13

• a substitute good’s price increase
• a complement’s price decrease
• increase in consumer income (for normal goods, not inferior)
• expectation of increased price in future
• favorable change in consumer preference (e.g. from ads)
• increase in total number of consumers

Question 14

What is supply?

Answer 14

The measure of how much producers, in aggregate, are willing and able to sell a given good at a given price

Question 15

How are the price of a good and the quantity supplied related?

Answer 15

Directly

Question 16

What does a supply curve generally look like?

Answer 16

With price on the y-axis and quantity supplied on the x-axis, a supply curve is a line (or curve) with a positive slope

Question 17

What are some examples of events that increase supply?

Answer 17

• lower costs of productions (including lower taxes related to production)
• technological improvements
• expected price decreases in the future (future supply would thus be relatively lower)

Question 18

What is economic rent?

Answer 18

An amount paid for a good beyond what the seller would have expected for it, given its scarcity or uniqueness

E.g. if a worker is willing to work for $17 per hour, given the quality he attributes to his labor, but actually gets paid $20 per hour since he belongs to a union, then the $3 per hour difference is his “economic rent”

Question 19

What is elasticity?

Answer 19

The degree to which some market variable (e.g. demand) reacts to a change in something else (e.g. price)

Question 20

What is the price elasticity of demand (Ed)?

Answer 20

The degree to which demand reacts to changes in price – whether a lot (elastic) or not at all (inelastic)

Question 21

What is the formula for price elasticity of demand?

Answer 21

Ed = % change in quantity demanded / % change in price

Ed = ΔQd /ΔP

Question 22

How does the price elasticity of a good relate to its corresponding demand curve?

Answer 22

The slopes will be inverse – the slope of the demand curve would be ΔP/ΔQd, whereas Ed = ΔQd/ΔP

Question 23

What are different things that increase the price elasticity of demand?

Answer 23

• how superfluous/luxurious a good is, rather than necessary
• how many substitutes an item has
• how much income (as a percentage) is spent on it

Question 24

How does price elasticity of demand relate to revenue received?

Answer 24

If a good has an elasticity of 1 (a “unitary elasticity”), then total revenue is not changed by price changes; the corresponding change in Qd is perfectly proportionate

If Ed > 1, it is elastic, so demand will respond more strongly to price changes; thus revenue would DECREASE with price increases and vice versa

If Ed < 1, it is inelastic, so demand will respond less strongly to price changes; thus revenue would INCREASE with price increases and vice versa

Question 25

What is the price elasticity of supply (Es)?

Answer 25

The degree to which supply reacts to changes in price -- whether a lot (elastic) or not at all (inelastic)

Question 26

What is the formula for price elasticity of supply?

Answer 26

Es = % change in quantity supplied / % change in price Es = ΔQs /ΔP As with demand, this would be the inverse slope of the corresponding supply curve

Question 27

What is the formula for cross elasticity of demand?

Answer 27

Exy (where X and Y are both goods) = % change in X's quantity demanded / % change in Y's quantity demanded Exy = ΔQdx /ΔQdy

Question 28

What does a different elasticity coefficient (Exy) say about the relation of goods X and Y?

Answer 28

If Exy > 0, then X and Y are substitutes If Exy = 0, then X and Y are unrelated If Exy < 0, then X and Y are complements

Question 29

What is income elasticity of demand (Ei)?

Answer 29

The degree to which the demand of a good reacts to changes in income Ei = ΔQd / Δ income

Question 30

What do different values for income elasticity of demand (Ei) indicate?

Answer 30

If Ei > 0, then the good is normal | If Ei < 0, then the good is inferior

Question 31

What is the equilibrium price (Pe)?

Answer 31

The price at which the quantity demanded and quantity supplied are the same (where Qd = Qs), i.e. where the demand and supply curves intersect -- called the equilibrium quantity (Qe) The equilibrium price is also called the market price, since this price naturally emerges in a free market

Question 32

What are price floors and price ceilings?

Answer 32

Minimum and maximum prices, respectively, that governments can set to alter the course of a free market Floors will tend to be ABOVE the equilibrium price, and ceilings BELOW

Question 33

How do price floors and price ceilings affect market activity?

Answer 33

Ideally, without any price fixing, the equilibrium price (Pe) and equilibrium quantity (Qe) will naturally emerge, Qs and Qd being exactly the same A price floor, however, sets the price above Pe, and thus leads to a higher Qs than Qd, leading to a surplus -a price ceiling will do the opposite, leading to a shortage

Question 34

What is the tragedy of the commons?

Answer 34

Common resources ("commons") can be depleted in the long run due to individuals' using that resource only for their self-interest Often includes environmental issues, like air and water purity

Question 35

What are externalities?

Answer 35

Someone who depletes common resources does not himself experience the brunt of the cost for its use; he at most pays a minimal cost as the entire cost of the resource's depletion is distributed over the whole society Because the cost of depleted resource is thus "outside" individual users, these costs are called externalities

Question 36

What is full-cost accounting?

Answer 36

Accounting that tries to move externalities, ordinarily placed upon the society, into the "internal" cost which individual users bear

Question 37

If demand increases when supply does not, how is the market affected?

Answer 37

The equilibrium price increases and equilibrium quantity decreases -vice versa if demand decreases without any change in supply

Question 38

If supply increases when demand does not, how is the market affected?

Answer 38

The equilibrium price decreases and equilibrium quantity increases -vice versa if supply decreases without any change in demand

Question 39

If supply and demand both increase proportionately, how is the market affected?

Answer 39

The equilibrium quantity increases, though the equilibrium price stays about the same

Question 40

If demand increases and supply decreases proportionately, how is the market affected?

Answer 40

The equilibrium price increases, though the equilibrium quantity stays about the same

Question 41

What is utility theory?

Answer 41

The doctrine that an individual will use all his income to maximize utility -- that a consumer will use his money a particular way (e.g. buying good X) until the marginal utility (e.g. using more dollars to buy more X) would not be as great as spending it a different way

Question 42

For utility theory, what is the utility maximization theory?

Answer 42

Utility has been maximized when A's marginal utility / A's price = B's marginal utility / B's price

Question 43

What are different ways to measure utility?

Answer 43

Cardinal = giving numeric values to the benefits a good gives Ordinal = giving a rank to the benefits that different goods give

Question 44

What is the principle of diminishing marginal utility?

Answer 44

Each additional increment of consumption for a good provides less utility than before E.g. the tenth slice of pizza is less pleasing than the first

Question 45

What is an indifference curve?

Answer 45

A graph that shows how two goods would benefit (give utility to) a given consumer Each axis measures the quantity of a good, and so any given curve thus shows the combinations of quantities that end up giving the same total utility to the customer -- e.g. a customer might be equally satisfied with 12 eggs and a gallon of milk as he would be with 32 eggs and a 1/2 gallon of milk Because the curve shows the different quantity-combinations at which the customer would receive equal utility, the customer would thus be INDIFFERENT to those different combinations -- any of them would equally please him

Question 46

Can there be multiple indifference curves on a single map?

Answer 46

Yes, indifference curves show what combinations of quantities of two goods would give a consumer a particular level of utility; therefore there can be various indifference curves for different levels of utility given An indifference curve for a higher level of utility will naturally be to the right of an indifference curve for a lower level of utility, since the consumer will marginally desire more quantities of those goods to give him that higher utility

Question 47

What is a graph called if it has multiple indifference curves?

Answer 47

An indifference map

Question 48

What shape are indifference curves?

Answer 48

Indifference curves are sloped negatively and convex (i.e. bulging towards the origin of the graph)

Question 49

Why are indifference curves sloped negatively?

Answer 49

Because the same level of utility can be provided by two goods only if one quantity is increasing and the other is decreasing; a consumer would not get the same utility from two goods if he decreased the quantities of both of them

Question 50

Why are indifference curves convex?

Answer 50

Because (1) consumers have diminishing returns and (2) consumers value variety - (1) causes the overall utility provided by an increase in quantity to be less and less - (2) means that consumers will require a greater increase in the quantity of X in order to part with a given quantity of Y -- e.g. if a man can choose from chips and cola, then he will be willing to part with one cola to get a bag of chips, but would be less willing to part with all his colas if he only got one bag of chips per cola; he would want more to compensate for his loss of variety

Question 51

Can indifference curves intersect?

Answer 51

No -- since the different curves represent different levels of utility (satisfaction) acquired from varying quantities of two goods, and since no consumer will receive the same level of utility from an increase (or decrease) in the quantity of both goods, then the curves necessarily cannot intersect

Question 52

How do budget constraints relate to indifference curves?

Answer 52

Budget constraints can establish what quantities of goods a consumer can purchase, and thus, when superimposed on an indifference map, can show the maximum amount of utility a consumer could receive with his income The slope of the budget constraint depends on the prices of the goods in question

Question 53

Regarding factors of production, what is the difference between the short run and the long run?

Answer 53

In the long run, by definition, all factors (inputs) are variable, since the business can choose to change them -- so the short run involves the time period during which at least one factor is fixed

Question 54

What are variable costs, fixed costs, and total costs?

Answer 54

``` Variable = change with the level of output Fixed = do not change with the level of output (only applicable to the short run) Total = sum of variable and fixed ```

Question 55

What is the difference between explicit and implicit costs?

Answer 55

Explicit costs are actual expenditures made (thus also called historical costs) Implicit costs include the opportunity cost foregone by using resources a certain way rather than another way (e.g. by renting land out rather than building a factory on it)

Question 56

What is the difference between economic and accounting profit/loss?

Answer 56

Accounting profit is the book revenue minus the book costs -- what people ordinarily refer to as "profit" But economic profit subtracts not only the book costs (the actual expenditures), but also the opportunity cost -- what revenues someone could have obtained if he had done the next-best option

Question 57

What is the purpose of calculating economic profit or loss?

Answer 57

Since economic profit also subtracts the revenues received from the next-best option, a positive economic profit thus means that one has selected the most rational alternative available A negative economic profit would mean that one has not selected the best alternative, whereas an economic profit of zero would mean that one has selected an alternative that is no better than the next-best one

Question 58

What is an example of calculating economic profit?

Answer 58

A restaurant owner has revenues of $750k and costs of $650k --> accounting profit of $100k The owner could have been a lawyer and made $150k in the year -- thus his economic profit (loss) was $100k - $150k = ($50k) This negative number means that it does not make sense (economically) for him to be a restaurant owner; it would be more economically rational for him to be a lawyer instead

Question 59

What are marginal revenue (MR), marginal cost (MC), and marginal profit?

Answer 59

The revenue earned, cost incurred, and profit earned by increasing the output by one unit

Question 60

What are marginal product (MP) and marginal revenue product (MRP)?

Answer 60

Marginal product (MP) = additional output gained by increasing input by one unit Marginal revenue product (MRP) = marginal revenue (MR) x marginal product (MP)

Question 61

As applied to marginal product, what is the principle of diminishing returns?

Answer 61

Further inputs will not always steadily increase outputs, but at some point will help less and less, and may at another point even decrease output

Question 62

What is an average cost curve?

Answer 62

A graph depicting the relation of the units of output (x-axis) and the cost per unit (y-axis) The graph sees how the (average) unit cost changes as the levels of output change

Question 63

What is the shape of an average cost curve?

Answer 63

It is U-shaped, and can generally be divided into three sections, moving horizontally: - the left side, where unit cost decreases as output increases - the middle, where the decrease in unit cost reaches a trough and then begins to increase - the right, where unit cost more rapidly increases as output increases

Question 64

What do the three different parts of an average cost curve represent?

Answer 64

Since the left side shows unit costs decreasing as output increases, it represents increasing returns to scale (i.e. economies of scale) - the middle represents constant returns to scale - the right represents decreasing returns to scale (i.e. diseconomies of scale)

Question 65

How does the average cost curve relate to the marginal cost curve?

Answer 65

They are best understood if superimposed: a marginal cost curve always intersects the avg. cost curve at its lowest point (in the U), is below the avg. cost curve before this point, and is above the avg. cost curve after this point Thus when there are increasing returns to scale, the marginal cost is below avg. cost, but not when there are decreasing returns to scale

Question 66

What are the characteristics of a purely competitive market?

Answer 66

The only factor distinguishing competitors is PRICE (not advertising, a unique product, etc.). Further a purely competitive market has: - many buyers and sellers acting independently - a homogeneous product - free entry into and exits from the market - "perfect information": all buyers and sellers are fully aware of all relevant info

Question 67

How do economic profits occur in purely competitive markets?

Answer 67

If economic profits are available in a purely competitive market, more firms will naturally enter, drive the price down, and reduce economic profits to zero Similarly, if an economic loss exists in such a market, more firms will naturally exit, the price will rice, and the economic losses will dwindle to zero

Question 68

What are the characteristics of a pure monopoly?

Answer 68

- one seller - good is unique; has no substitutes - other firms cannot enter - perfect information - price controls - good-faith advertising

Question 69

What is a natural monopoly?

Answer 69

A case where technological or economic conditions permit only one supplier to efficiently exist E.g. for electric companies, the cost of infrastructure is so great that it would be extremely inefficient to have more than one competing in a given region

Question 70

What is the Sherman Act?

Answer 70

1890 act that forbids restraints on interstate and international trade, including: - resale restrictions - agreements to divide markets - price fixing - boycotts

Question 71

What is the Clayton Act?

Answer 71

1914 act that - forbids mergers of stock which unduly restrict competition - forbids price discrimination - forbids people from being directors for two competing corporations

Question 72

What is the Robinson-Patman Act?

Answer 72

1936 act that forbids discounts which aren't based on cost differences for large purchasers

Question 73

What is the Celler-Kefauver Anti-Merger Act?

Answer 73

1950 act that forbids mergers of assets which unduly restrict competition

Question 74

How does monopolistic competition differ from a pure monopoly?

Answer 74

Monopolistic competition offers a large number of sellers whose products are not uniform, but differentiated by substantial nonprice competition -also involves easy entry into and exit from markets and sometimes price controls In many ways monopolistic competition is closer to pure competition than to a monopoly

Question 75

What are the characteristics of an oligopoly?

Answer 75

- very few sellers, though more than one - high barriers to entry -- whether natural (e.g. high cost) or created (e.g. brand recognition) - products can be differentiated or uniform - high awareness of competitors' actions

Question 76

How is price leadership significant for oligopolies?

Answer 76

Because competitors are very aware of each other in oligopolies, they will be very inclined to match price reductions

Question 77

How do cartels relate to oligopolies?

Answer 77

Cartels are oligopolies which collude to fix prices This is illegal in the U.S. but not everywhere (e.g. OPEC is a famous cartel)

Question 78

What is a situation in which a firm will always (to be rational) cease production?

Answer 78

If the market price is less than the average variable cost

Question 79

What are some arguments against companies that naturally monopolize a market?

Answer 79

(1) such market power can lead to unfair pricing practices | (2) little innovation to improve product, because there's no one else from whom to differentiate it

Question 80

What are some arguments for companies that naturally monopolize a market?

Answer 80

(1) their resources are then freed up to be risked in R&D, developing the product more for customers' benefit (2) economies of scale can aid customers

Question 81

What are two different kinds of ways to measure how monopolistic a company is?

Answer 81

(1) performance measures = profit, market performance, efficiency, technological growth (2) market structure = number of competitors, strength/size of competitors, barriers to entry, product differentiation

Question 82

What is the concentration ratio for a market?

Answer 82

The percentage of a market's output provided by its four largest firms Relates to measuring how monopolistic a market is

Question 83

What are various examples of how the government can support monopolistic activities/restrict competition?

Answer 83

(1) intellectual property (patents, trademarks, etc.) (2) price ceilings (e.g. with utilities) (3) costs to comply with regulations (effectively a fixed tax) (4) licensing

Question 84

What are three different kinds of mergers?

Answer 84

(1) vertical = along a supply chain (2) horizontal = between competitors on the same level (3) conglomerate = between firms in unrelated markets