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EC120 Midterm Review
Introduction to Microeconomics (Wilfrid Laurier University)
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Chapter 1: Economic Issues and Concepts
● Scarcity → Choices must be made making choices implies the existence
of costs
● Opportunity Costs → Choosing any alternative is the value of the next
best alternative
○ Ex: six kilometres of bicycle path must be given up for three extra
kilometres of road repair, therefore, each kilometre of road repair “costs”
two kilometres of new bicycle path (6/3=2)
○ If resources are scarce, choices imply forgone alternatives
If you make one choice, which choice you didnt make
Only worried about your one best alternative
○ These alternatives are defined as the “opportunity cost” of a choice
○ Opportunity cost may be defined in monetary terms
○ Better to define it as the value of an alternative choice
● Sunk Costs- cost of something that you already paid but that's behind you. Ex
drop out of university today, you won't get registration back but you will get tuition
back. Registration is a sunk cost
● Production Possibilities Frontier
○ Graph showing possible combinations of output
○ Can be used to think about economic growth
○ Simplification to two outputs (often) one input
○ Highlights two main concepts
■ Tradeoffs, opportunity cost
■ Efficiency
○ Can be used to think about economic growth
● Concave shape of the PPF indicates that opportuniuty cost of either good
increases as we increase
● Feasible: anything inside the line
● Efficient: Anything on the line, just because it is efficient does not mean it is
good
● Scarcity=unnatainable conditions outside boundary
● Choice=need to choose among alternative attainable points along boundary
● Opportunity cost= negative slope of boundary
● Moving along PPF shows opportunity cost
● Opportunity cost of X is the (negative) slope,
● Oppprtunity cost of Y is the reciprocal of the slope
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Economy’s
● Traditional economy- an economy where behaviour is based mostly on tradition
● Command economy- an economy in which most economic decisions are made
by a central planning authority
● Free market economy- An economy where most economic decisions are made
by private households and firms
Chapter 2: Economic Theories, Data and Graphs
●
●
Normative statement- A statement about what ought to be; it is based on a value
judgement
Positive statement- A statement about what actually is, was, or will be; it is not based on
a value judgement
Chapter 3: Demand Supply and Price
● Quantity Demanded and Price- The quantity demanded are related negatively,
other things being equal. The lower the price, the higher the quantity demanded;
the higher the price the lower the quantity demanded
● Substitutes in consumption- Goods that can be used in place of another goof to
satisfy similar needs or desires
● Complements in consumption- Goods that tend to be consumed together
● Shifts in Demand Curve○ An increase in demand means the demand curve shifts to the right,
quantity demanded is higher at each price
○ A decrease in demand means the demand curve shifts to the left
● Shifts in a Demand Curve○ Increase in the quantity supplies causes a rightward shift
○ Decrease in the quantity supplied causes a leftward shift
○ Price of inputs,technology, goverment tax or subsides, price of other
profuces, significant changes in the weather, number of suppliers
● Absolute price- The amount of money that must be spent to acquire one unit of a
product
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● Relative price- The ratio of the money price of one product to the money price of
another product; that is, a ratio of two absolute prices
● The Shape of the PPF
○ A PPF may be linear
■ Why would this be true?
Or a PPF may be bow-shaped
○ Could a PPF bend inward, toward the origin?
■ Inward- if you try and produce both you wouldn't get as many
■ Outward- you can produce more if you try and produce both
○ Increase in resources = parallel growth
○ Get better at producing one thing= the slope decreases, the opportunity cost
decreases
●
Market
○ Group of buyers and sellers of a good or service
○ Organized or discouraged
○ Oil market (organized)- Babysitter in my neighbourhood (disorganized)
○ Size of a market depends on the nature of the good
●
Key issue for government policy - Canadan Competition Bureau
○ The competition bureau as an independent law enforcement agency ensures that
canadaian businesses and consumers proper in a competitive and innovative
market place
○ Sobeys and loblaws can't merge, some other companies can but they may have
to sell stores
● Competition:
○ Competitive markets require that there are many buyers, with free choice
■ Know what's available for sale and quality
■ Perfectly competitive are almost impossible to find
○ Homogeneous products - no brand differentiation
○ Numerous buyers and sellers
○ If there is only one seller - monopoly
○ If there are a few sellers - oligopoly
○ Perfect Competition is are - but a useful starting point
■ To talk about salary people make as a supply and demand function
is probably not true
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● Prices of Related Goods =
○ Increases price X increases demand for Y - substitutes
■ Coffee and tea, apples and oranges
○ Increases price X reduces demand for Y - complements
■ Houses and morgates (interest rates), cars and gasoline
Chapter 4: Elasticity
● When does elasticity matter?
○ Business Strategy
○ Optimal pricing strategies for companies
● Tax Policy
○ What happens if we raise taxes on the richest 1%?
● Environmental Policy
○ What would be the effect of a gasoline or carbon tax
● International Issues
○ Why are food prices highly volatile?
●
● Price Elasticity of Demand
○ Demand is said to be elastic when quantity demanded is quite responsive
to price changes
○ ท=
Percentage change in the quantity demanded
Percentage change in price
○ Demand elasticities are computed in terms of the average values of each
○ ท= ΔQ/Q / Δp/p
○ When the percentage chaneg in quantity demanded is less than
the percentage change in price (ท <1) it is inelastic demand
○ When the percentage change in quantity demanded is greater
than the percentage change in price (ท>1) it is elastic demand
● Are there close alternatives?
●
● Necessities vs luxuries?
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○ Inelastic demand for pharmaceuticals
○ No matter what the price it is you will pay
● Elastic demand for travel
○ Leisure travel; if price goes up you wont go
● Definition of the market
○ Rice is a substitute for wheat
○ There are no substitutes for food
● Elasticity of demand for food will be lower than wheat
● Time Horizon
○ Alternatives may take time to exploit
○ Demand for gas in the short term is inelastic
○ In the long term, alternatives make it more elastic
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● Price Elasticity of Supply
Percentage change in the quantity supplied
○ ท=
Percentage change in price
○ When the percentage chaneg in quantity demanded is less than
the percentage change in price (ท <1) it is inelastic supply
○ When the percentage change in quantity demanded is greater
than the percentage change in price (ท>1) it is elastic supply
● The long run supply curve is more elastic than the short run supply curve
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● Elasticity Matters for Excise Taxes
● Ask for help page 87 Figure 4-8
○ Excise tax: a tax on the sale of a particular product
○ Tax incidence: the location of the burden of a tax; that is the identity of the
ultimate bearer of the tax
○ When demand is inelastic relative to supply, consumers bear most of the
burden of excise taxes. When supply is inelastic relative to demand,
produces bear most of the burden
● Income Elasticity of Demand
○ A measure of the responsiveness of quantity demanded to a change in
income
○ Normal good- a good for which quantity demanded rises as income rises;
its income is elasticity
○ Inferior good- a good for which quantity demanded falls as income rises
○
○ ท=
Percentage change in the quantity demanded
Percentage change in income
● Cross Elasticity of Demand
○ A measure of the responsiveness of the quantity of ones product
demanded to changes in the price of another product
● ท=
Percentage change in the quantity demanded of good X
Percentage change in price of good Y
● If X and Y are substitutes, an increase in the price of Y leads to an increase in
the demand for X
● If X and Y are complements, an increase in the price of Y leads to a reduction in
the demand for X
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Chapter 5: Price Controls and Market Efficiency
● Disequilibrium Prices
○ At and disequilibrium price, quantity exchanged is determined by the
lesser of quantity demanded and quantity supplied
● Price Floors
○ Governments sometimes establish a price floor, which is the minimum
permissible price that can be charged for a particular good or service
○ If the price floor is set above the equilibrium it will raise the price it which
case it said to be binding
■ Binding price floors lead to excess supply. Either an unsold surplus
will exist, or someone (usually the government) must enter and buy
the excess supply
● Price Ceilings
○ The maximum price at which certain goods and services may be legally
exchanged
○ If it is set above the equilibrium price it has no effect
○ If it is set below the equilibrium price, the price ceiling lowers the price and
is said to be binding
■ Binding price ceilings lead to excess demand, with the quantity
exchanged being less than in free market equilibrium
● Black markets
○ Binding price ceiling always create the potential for a black market
because a profit can be made by buying at the controlled price and selling
at the (illegal) black-market price
Chapter 6:Consumer Behaviours
● Utility
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○
○
○
○
Utility as a concept
Utility is a conceptual measure of consumer satisfaction or value
Assume that consumers make choices to maximize utility
Assess utility based on observed consumer choices
■ Circular nature of the argument is important
■ Consumers are assumed to value those things they choose to
consumer
○ Based on the choices people make, you must be getting some value out
of it
● Total Utility
○ The consumers total satisfaction from the consumption of a given product
● Marginal Utility
○ The additional satisfaction obtained from consuming one additional unit of
a product
● Law of diminishing marginal utility
○ The utility that any consumer derives from successive units of a particular
product consumed over some period of time diminishes as total
consumption of the product increases (holding constant the consumption
of all other products)
● Maximizing Utility
○ A utility-maximizing consumer allocates expenditures so that the marginal
from the last dollar spent on each product is equal
○ MUx/Px = MUy/Py
■ MU= The marginal utility of the last dollar spent on X or Y
■ P= Its price
● Consumer Demand Curve
○ Individual demand curved derived from utility maximization
■ Marginal utility is declining
■ As price increases, number of units purchased falls
■ Individual demand curve sloped downward
● Market demand curves
○ Individual demand curves added together
○ Market demand curves slope downward
● The Substitution Effect
○ The change in the quantity of a product demanded resulting from a
change in its relative price
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●
●
●
●
●
○ Increases the quantity demanded of a product whose price has fallen and
reduces the quanity demanded of a product whose price has risen
Income Effect
○ Leads consumers to buy more of a product whose price has fallen,
provided that the product is a normal good
The slope of the demand curve
○ Because the combined operation of the income and substitution effect, the
demand curve for any normal curve will be negativley sloped. A fall in price
will increase the quantity demanded
Giffen Goods
○ Inferior good
○ Takes up a large proportion of total household expenditure and therefore
have a large income affect
○ An inferior goof for which the income effect outweighs the substiution
effect so that the demand curve is positivley sloped
○ When I feel poorer i buy much more of a good
Consumer Surplus
○ The difference between the maximum amount the consumer is willing to
pay for that unit and the price the consumer actually pays
Paradox of value
○ The paradox of value can be resolves by understanding (1) the market
price of a good depends on both demans and supply, (2) the difference
between the total and marginal value that consumers place on a good.
Water has a low price and low marginal value, but a high total value.
Diamonds have a high price and a high marginal value, but a low total
value.
Appendix to Chapter 6: Indifference Curves
● Indifference Curves
○ The consumer is indifferent between the combinations indicated by any
two points on one indiference curve.
○ Any point above an indifference curve is preffered to any point along that
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same indifference curve; any point on the curve is preferred to any point
below it.
● Diminishing Marginal Rate of Substitution
○ The first basic assumption of indifference theory is that the algerbraic
value of the MRS (amount of one product that a consumer is willing to give
up to get one more unit of amount) between two goods is always negative
○ Negative MRS means that to increase consumption of one product one is
prepared to decrease consumption of another product
● The Budget Line
○ Shows all combinations of products that are available to the consumer
given his money income and the prices of the goods he purchases
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