Exam 2 Study Guide

Study Guide Outline

Chapter 6: Consumer Theory (Some of this was on Exam 1)

Budget constraint o

Budget Line

P

X

/P

Y

= Relative price of X; opportunity cost of one more unit of X; absolute value of slope of budget line

Changes in Income

Changes in Price

Preferences o

Rational o

More is better

Goal

Maximize Utility o

Law of Diminishing MU

Consumer equilibrium o

Finding it using MU approach

MU/P o

Changes in Income

Inferior/ Normal goods o

Changes in Price

Consumer Demand Curve

Income and Substitution effects of Price change o

Normal Good o

Inferior Good o

Giffen Good (theoretical)

Individual to market demand

Irrational Preferences and Behavioral Economics

Chapter 7: Production and Cost

Accounting (Explicit) costs vs. Economic (Implicit) costs

Law of diminishing Marginal Returns

SR vs. LR o

Fixed and variable costs

Cost curves o

MC o

AVC o

ATC

LRATC o

Economies of scale o

Diseconomies of scale o

Constant returns to scale

Chapter 8: Profit-maximization

Calculate profit: π = TR - TC

Accounting π vs. Economic π

Goal of firm

Demand and cost constraints

How to choose profit-maximizing output o

TR TC approach: Calc 𝜋 = 𝑇𝑅 − 𝑇𝐶

at each output level and compare o

MR MC approach: Choose q where MR=MC

Shut-down rule o

TR < TVC

Shut down

Chapter 9: Perfect Competition (Supplemental handouts available)

Characteristics

Goal of perfectly competitive firm

How to choose output

Shut-down rule o

P < AVC

Shut down

SR vs. LR o

SR: # firms is fixed o

LR: # can change o

EQM in SR o

EQM in LR

Profit/Loss and entry/exit

Different cost industries

Chapter 10: Monopoly (Supplemental handouts available)

Characteristics

Barriers to entry o

Natural o

Legal o

Network Externalities

Goal of monopolistic firm

How to choose output

SR vs. LR

Monopoly vs. Perfect Competition o

Generally P

M

>P* and Q

M

<Q*

Government involvement o

Regulation o

Rent-seeking behavior

Price Discrimination o

Conditions o

Perfect Price Discrimination o

Choosing Multiple Prices o

In Everyday Life

Chapter 14: Economic Efficiency

Economic efficiency

Pareto improvements

Efficient quantity

Measuring market gains (Consumer and Producer Surplus)

Inefficient markets and Deadweight Loss o

Price ceiling & Price floor o

Significant market power (i.e. monopoly) o

Excise taxes

Chapter 15: Government’s Role in Economic Efficiency

Market Failures and solutions o

Monopoly

Anti-trust Law

Regulation (natural monopoly)

Marginal Cost Pricing

Average Cost Pricing o

Externalities

Positive Externality

Marginal Social Benefit

Subsidy

Negative Externality

Marginal Social Cost

Pigovian Tax

Coase Theorem

Private market can solve externality problem if side payments can be o made without cost

Public Goods

Characteristics

Nonrival

Non-excludable

Free-rider Problem

Government Provision

Tragedy of the Commons (overuse of common resources) o o

Asymmetric Information

A good reputation can help

Moral Hazard (future behavior)

Higher rates for riskier behavior

Principal-Agent Problem

Incentives for agent to act in accordance with principal’s wishes

Government Policies

Sometimes policies can be the cause of economic inefficiency