ECON 202:
Principles of
Microeconomics
Review Session for Exam 1
Chapters 1 - 4
Review Session for Exam 1
1.
2.
3.
4.
Economics: Foundations and Models.
Trade-offs, Comparative Advantage, and the Market
System.
Interaction of Demand and Supply.
Economic Efficiency, Government Price Setting, and
Taxes
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
2
1. Economics: Foundations and Models
„
„
„
Economics is the study of the choices people make to
attain their goals, given their scarce resources.
Scarcity: when unlimited wants exceed the limited
resources available to fulfill those wants.
Choices imply sacrifice something, because resources
are always scarce.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
3
1. Economics: Foundations and Models
„
„
Three important economic ideas
People are rational
„
„
Rational individuals weigh the benefits and costs of each action,
given the information available, and choose when benefits
exceeds cost.
Consumer and firms consistently respond to economic
incentives.
Optimal decisions are made at the margin
Most decisions involve doing a little more or a little less.
Optimal decision is to continue any activity up to the point where
Marginal Benefit = Marginal Cost.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
4
1. Economics: Foundations and Models
„
Every society must decide:
What goods and services will be produced?
How will the goods and services be produced?
Who will receive the goods and services produced?
„
Types of organization:
Central planned economies
Market economies:
„
„
„
Privately owned firms decide what to produce and how to produce it.
Consumers decide to buy according to their wants.
Exchanges are produced in the market.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
5
1. Economics: Foundations and Models
„
„
Markets tend to be more efficient than centrally planned
economies.
Productive efficiency: goods or services produced at the
lowest cost.
„
Allocative efficiency: production is in accordance with
consumer preferences.
„
Achieved through firms competition in the market.
Achieved through a combination of competition and voluntary
exchange.
However:
Markets do not always guarantee efficiency.
Markets do not guarantee equity.
Market not always work well.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
6
1. Economics: Foundations and Models
„
Economic Model
A simplification of the real world with explanatory power.
It captures only the most important aspects considered to make
an economic decision, in order to explain it.
„
„
„
Positive analysis: What is?
Normative analysis: What ought to be?
Microeconomics is the study of
„
How households and firms make choices, their interaction in
markets and the government attempts to influence their choices.
Macroeconomics is the study of the economy as a whole
Inflation, unemployment, economic growth (aggregate variables)
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
7
2. Trade-offs, Comparative Advantage,
and the Market System
„
A Production Possibility Frontier (PPF) shows the
maximum attainable combinations of two products that
may be produced with available resources and current
technology.
„
„
Shows the opportunity cost of production of each good.
Opportunity Cost: The highest-valued alternative that
must be given up to engage in an activity.
In most cases, the more resources devoted to an
activity, the smaller the payoff to devoting additional
resources to that activity.
Some resources are better suited to one use than for another.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
8
2. Trade-offs, Comparative Advantage,
and the Market System
„
Increasing Marginal Opportunity Costs.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
9
2. Trade-offs, Comparative Advantage,
and the Market System
„
Economic growth: The ability of the economy to produce
increasing quantities of goods and services.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
10
2. Trade-offs, Comparative Advantage,
and the Market System
„
Comparative Advantage.
„
Absolute advantage.
„
Ability of an individual, a firm or a country to produce a good or
service at a lower opportunity cost than competitors.
Ability of an individual, a firm, or a country to produce more of a
good or service than competitors, using the same amount of
resources.
Markets are fundamentally about trade.
Make possible for people to become better off by increasing
production and consumption when people specialize and trade.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
11
2. Trade-offs, Comparative Advantage,
and the Market System
„
Specialization and gains from trade
OPPORTUNITY COST OF PICKING
1 POUND OF APPLES
OPPORTUNITY COST OF PICKING
1 POUND OF CHERRIES
YOU
1 pound of cherries
1 pound of apples
YOUR NEIGHBOR
2 pounds of cherries
0.5 pounds of apples
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
12
2. Trade-offs, Comparative Advantage,
and the Market System
„
The market system
The Circular-Flow Diagram
Not included:
• Government
• Exports and Imports
• Financial sector
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
13
3. Interaction of Demand and Supply
„
Perfect competition.
Many buyers and sellers.
Firms sell the identical products.
Free entry.
Demand side of the market
„ Law of demand:
Holding everything else constant, when the price of a product
falls, quantity demanded will increase.
Substitution effect: change in quantity demanded from a change
in price, making the good more or less expensive relative to
other goods that are substitutes.
Income effect: change in quantity demanded from the effect of a
change in good’s price on consumers’ purchasing power.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
14
3. Interaction of Demand and Supply
„
Variables that shift demand
Income
„
„
„
Prices of related goods
„
„
Increase in income shifts curve to the right.
Normal good: more income, demand increases.
Inferior good: more income, demand decreases.
Increase in price of substitute, shifts demand to the right.
Increase in price of complement, shifts demand to the left.
Tastes
„
When consumer’s taste for a product increase demand curve shifts
to the right.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
15
3. Interaction of Demand and Supply
„
Variables that shift demand (cont.)
Population and Demographics
„
„
Expected Future Prices
„
„
Number and characteristics of a population.
Additional consumers shift demand to the right.
Expectative of a higher price in the future will shift demand to the
right.
Change in supply ≠ change in quantity demanded.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
16
3. Interaction of Demand and Supply
Supply side of the market
„ Law of Supply.
Holding everything constant, increases in price causes increases
in the quantity supplied.
Most supply curves obey this law.
„
Variables that shift supply.
Prices of inputs.
„
Technological changes
„
„
Increase in price of inputs shift supply to the left.
Positive technological change happens when the productivity of
workers or machines increases.
Positive technological change shifts supply curve shifts to the right.
Prices of Substitutes in Production
„
Increase in price of substitute shift supply curve will shift to the left.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
17
3. Interaction of Demand and Supply
„
Variables that shift supply (cont.)
Number of firms in the market
„
Expected future price
„
„
„
When new firms enter the market, supply curve shifts to the right.
Higher expected future price shifts supply curve to the left.
Only a change in the price of the good graphed, will
cause a movement along the curve.
All other factors affecting the demand or supply of a
good will cause a shift in the curve.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
18
3. Interaction of Demand and Supply
„
Market equilibrium
Quantity demanded equals quantity supplied.
Only at market equilibrium the quantity of goods consumers are
willing to buy equals the quantity of goods firms are willing to sell.
„
Surpluses and
shortages.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
19
3. Interaction of Demand and Supply
„
Effect of shifts in supply on equilibrium
A new firm in the market
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
20
3. Interaction of Demand and Supply
„
Effect of shifts in demand on equilibrium
Population and income growth
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
21
3. Interaction of Demand and Supply
„
Effect of shifts in demand and supply over time
When both curves shift, the final effect on price and quantity
depends on the magnitudes of the shifts.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
22
4. Economic Efficiency, Government
Price Setting, and Taxes
„
„
Demand curve depicts the marginal benefit.
Supply curve is also the marginal cost curve.
Marginal cost increases as more resources are used.
Supply curves are usually upward sloping.
„
Consumer surplus measures the net benefit to
consumers from participating in a market.
„
Total benefit received by consumers minus the total amount they
pay to buy the good.
Producer surplus measures the net benefit received by
producers from participating in a market
Total amount firms receive minus the cost of producing the good.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
23
4. Economic Efficiency, Government
Price Setting, and Taxes
„
At competitive equilibrium:
Marginal benefit equals marginal cost.
Sum of consumer surplus and producer surplus is at maximum.
Economically efficient result.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
24
4. Economic Efficiency, Government
Price Setting, and Taxes
„
Price floor
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
25
4. Economic Efficiency, Government
Price Setting, and Taxes
„
Price ceiling
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
26
4. Economic Efficiency, Government
Price Setting, and Taxes
„
Taxes: Federal tax of $1-per-pack on cigarettes, paid by
sellers.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
27
4. Economic Efficiency, Government
Price Setting, and Taxes
„
Taxes reduce Consumer Surplus and Producer Surplus.
„
Part of this reduction goes to government as tax revenue.
„
The rest is lost:
Deadweight loss or excess burden of the tax.
„
Whoever collects the tax is not necessarily who actually
bears the burden of the tax.
„
Actual division of the burden of the tax: tax incidence
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
28
4. Economic Efficiency, Government
Price Setting, and Taxes
„
Consumers pay 8 cents and producers 2 cents per unit,
regardless of who is legally required to collect the tax.
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
29
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
30
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
31
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
32
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
33
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
34
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
35
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
36
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
37
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
38
Problems
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
39
Problems
7.50
ECON 202: Princ. of Microeconomics
Review Session for Exam 1
40
ECON 202:
Principles of
Microeconomics
Review Session for Exam 1
Chapters 1 - 4