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Cheat Sheet

ECON 200


Table of contents
  1. Midterm Study Guide
    1. Reminders
    2. Key Points from Each Chapter
      1. Chapter 1: Economics and Life
      2. Chapter 2: Specialization and Exchange
      3. Chapter 3: Markets
      4. Chapter 4: Elasticity
      5. Chapter 5: Efficiency
      6. Chapter 6: Government Intervention
  2. Final Study Guide
    1. Reminders
    2. Equations
    3. Key Points from Each Chapter
      1. Chapter 17: International Trade
      2. Chapter 18: Externalities
      3. Chapter 12: The Costs of Production
      4. Chapter 13: Perfect Competition
      5. Chapter 14: Monopoly
      6. Chapter 15: Monopolistic Competition

Midterm Study Guide

Reminders

  • Remember units (e.g. “thousands of cars”) when calculating and giving answers.
  • When calculating price effect and quantity effect, one is positive and negative. That is, do not measure effect by its absolute value but its change.
  • Read closely; do not confuse price elasticity of demand with percent change in quantity demanded, for instance.
  • Make sure you address all parts of the problem - read closely! Many problems on the midterm
  • Take time to show your work - you get points for it.
  • Always draw a graph, both so you can get credit and to get a solid understanding of the situation.
  • When calculating something, always write out the full formula - you will get points for it.

Key Points from Each Chapter

Chapter 1: Economics and Life

  • Scarcity: wanting more than we can get with available resources. Scarcity is a fact of life.
  • Opportunity cost: the opportunity you must give up for something that you might have enjoyed otherwise.
  • Marginal decision-making: rational people compare the additional benefits of a choice against the additional costs, without considering related benefits and costs of past choices.
  • Incentive: something that causes people to behave in a certain way by changing their trade-offs.

Chapter 2: Specialization and Exchange

  • Production Possibilities Frontier (PPF): a curve showing all possible combinations of outputs that can be produced using all available resources.
    • Points that lie on the PPF are efficient.
    • Points that lie inside the PPF are inefficient.
    • Points that lie outside the PPF are unattainable.
  • An increase in available resources shifts the frontier outward; an improvement in technology for a good rotates the frontier outward.
  • Absolute advantage: a producer can generate more output than others with a given amount of resources.
  • Comparative advantage: a producer can make a good at a lower opportunity cost than other producers.
    • Countries can have a comparative advantage without having an absolute advantage.
    • No producer has a comparative advantage at everything.
  • Specialization: focusing on producing a good for which it has a comparative advantage. Total production increases.

Chapter 3: Markets

  • Assumptions of competitive markets: price taker, standardized good, no transaction costs.
  • Demand: how much of something people are willing or able to buy under certain circumstances. As price increases, demand decreases.
    • Nonprice determinants of demand: consumer preferences, price of related goods (substitutes or complements), the income of customers (inferior or normal good), expectations of future prices, number of buyers in the market.
  • Supply: how much of a good or service producers will offer. As price increases, supply increases.
    • Nonprice determinants of supply: prices of related goods, technology, prices of inputs, expectations, number of sellers.
  • Market equilibrium: intersection of demand and supply curves. \(Q_\text{supplied} = Q_\text{demanded}\)
    • Excess supply/”suplus”: \(Q_\text{supplied} > Q_\text{demanded}\)
    • Excess demand/shortage: \(Q_\text{supplied} < Q_\text{demanded}\)
Supply ChangeDemand ChangeEqu. Price ChangeEqu. Quantity Change
DownNoneUpDown
UpNoneDownUp
NoneDownDownDown
NoneUpUpUp
DownDown?Down
DownUpUp?
UpUp?Up
UpDownDown?

Chapter 4: Elasticity

  • Elasticity: a measure of how much consumers and producers will respond to a change in market conditions.
    • Price elasticity of demand and price elasticity of supply: how much quantity demanded and quantity supplied change when the price of good changes.
    • Cross-price elasticity of demand - how much the demand curve shifts when the price of another good change.
    • Income elasticity of demand - how much the demand curve shifts when consumer incomes change.
  • Determinants of price elasticity of demand: availability of substitutes, degree of necessity (necessity or luxury), cost relative to income, adjustment time, the scope of the market.
  • Determinants for price elasticity of supply: availability of inputs, the flexibility of the production process, adjustment time.
  • Remember that:
    • Elasticity varies along the curve/line. Demand tends to be more elastic when the price is high.
    • Slope is not the same thing as elasticity. It can, however, roughly indicate the elasticity between two points.
  • If the cross-price elasticity of demand is positive, two goods are substitutes; otherwise, they are complements.
  • If the income elasticity of demand is positive, the good is normal; otherwise it is inferior.
  • If the income elasticity of demand is less than 1 but positive, it is a necessity; if it is larger than 1, it is a luxury good.

Formulas

\[\text{\% change in qty demanded/supplied} = \frac{Q_2 - Q_1}{\left(\frac{Q_2 + Q_1}{2}\right)}\] \[\text{\% change in price} = \frac{P_2 - P_1}{\left(\frac{P_2 + P_1}{2}\right)}\] \[\text{Price elasticity of demand/supply} = \frac{\text{\% change in qty demanded/supplied}}{\text{\% change in price}} = \frac{\left(Q_2\:-\:Q_1\right)\left(\frac{P_2\:+\:P_1}{2}\right)}{\left(\frac{Q_2\:+\:Q_1}{2}\right)\left(P_2\:-\:P_1\right)}\] \[\text{Cross-price elasticity of demand between A and B} = \frac{\text{\% change in quantity of A demanded}}{\text{\% change in price of B}}\] \[\text{Income elasticity of demand} = \frac{\text{\% change in quantity demanded}}{\text{\% change in income}}\]

Chapter 5: Efficiency

  • Surplus: measures the benefits people receive when they buy something for less than they would have been willing to pay.
  • Total surplus: combined benefits everyone receives from participating in the exchange of goods and services. Usually the sum of the consumer and producer surplus.
  • The equilibrium in a perfectly competitive, well-functioning market maximizes total surplus.
  • Deadweight Loss: the loss of total surplus that occurs when the quantity of a good is below market equilibrium quantity.

Chapter 6: Government Intervention

  • Governments intervene to change the distribution of surplus, encourage/discourage consumption, and correct market failures.
  • Price control: regulating the maximum or minimum legal price for a good.
    • Price ceilings are nonbinding if they are higher than the equilibrium price; price floors are nonbinding if they are lower.
  • Taxes: discourage production and consumption, raise government revenue.
    • A tax on the seller shifts the supply curve leftward/upward; a tax on the buyer shifts the demand curve leftward/downward.
    • Equilibrium price and quantity decrease.
    • Whoever (buyers or sellers) is more elastic shoulders less of the tax burden.
  • Subsidies: encourage production and consumption.
    • Equilibrium price and quantity increase.
    • Whoever (buyers or sellers) is more elastic receives less of the benefit.
  • The more elastic the supply or demand, the greater effect a tax will have on the equilibrium quantity.

Final Study Guide

Reminders

  • When looking at how many units a firm produces, check if the market price is below the shutdown price.
  • When calculating marginal [anything], make sure to consider the change in the unit and divide by it - do not assume it is 1.
  • Always check units (millions, thousands, etc.)
  • Take time to explain out the rules and formulas. Explain more than less to hit all the desired points.
  • Look at the textbook for key points in conceptual questions if time.

Equations

\[\text{revenue} = \text{quantity} \times \text{price}\] \[\text{profit} = \text{revenue} - \text{total cost} = (P - ATC) \times Q\] \[\text{accounting profit} = \text{total revenue} - \text{explicit costs}\] \[\text{economic profit} = \text{total revenue} - \text{explicit costs} - \text{implicit costs}\] \[\text{average fixed cost (AFC)} = \frac{\text{fixed cost}}{\text{quantity of output}}\] \[\text{average variable cost (AVC)} = \frac{\text{variable cost}}{\text{quantity of output}}\] \[\text{average total cost (ATC)} = \frac{\text{total cost}}{\text{quantity of output}}\] \[\text{marginal cost} = \frac{\Delta \text{ total cost}}{\Delta \text{ quantity}}\]

Perfectly Competitive Market

\[\text{profit-maximizing quantity}: \text{where } MC = MR\] \[\text{SR shutdown condition}: \text{shut down if} P < AVC\] \[\text{LR shutdown condition}: \text{shut down if} P < ATC\]

Monopoly Market

\[\text{profit-maximizing quantity}: \text{where } MC = MR\] \[\text{revenue-maximizing quantity}: \text{where } MR = 0\] \[P > MC \text{ at optimal production point}\] \[MR < P \text{ (always)}\]

Three Markets Table

CharacteristicPerfect CompetitionMonopolyMonopolistic Competition
How many firms?Many firmsOne firmMany firms
Price taker or price maker?Price takerPrice makerPrice maker
Marginal revenue?\(MR = \text{Price}\)\(MR < \text{Price}\)\(MR < \text{Price}\)
Profit-maximizing quantity occurs at\(MR = MC\)\(MR = MC\)\(MR = MC\)
Can earn economic profits in short run?YesYesYes
Can earn economic profits in the long run?NoYesNo
Quantity is efficient?YesNoNo

Key Points from Each Chapter

Chapter 17: International Trade

  • Comparative advantage comes from natural resources and climate, factor endowment, or technology.
  • Autarky: no trade, a self-contained economy.
  • If \(\text{autarky domestic price} > \text{world price}\), the product is imported. Otherwise, it is exported.
  • Tariff: tax on imported goods. Causes deadweight loss and is inefficient. Used to protect domestic producers at the expense of consumer surplus. Government receives tax revenue.
  • Import quota: the limit on how much of a particular good can be imported. Foreign agents benefit from the right to import the good (money that would have been tax revenue).

Chapter 18: Externalities

  • Types of costs
    • Private costs: costs that fall directly on the economic decision-maker.
    • External costs: uncompensated costs imposed on someone other than the person who caused them.
    • Social cost: sum of private costs and external costs.
  • Types of externalities
    • Negative externality: an external cost. The problem of “too much” (externality results in more production/consumption than is efficient).
    • Positive externality: an external benefit. The problem of “too little” (externality results in less production/consumption than is efficient).
    • Network externality: the effect the user of a good has on the value of that good for others. People help or harm others simply by participating in a group.
    • Production externality: externality that occurs when a good or service is being produced.
    • Consumption externality: externality that occurs when a good or service is being consumed.
  • Externalities are one of the most common causes of market failure.
  • Coase theorem: individuals can reach an efficient equilibrium through private trades, even in the presence of an externality. The distribution of surplus may not be “fair”, but the solution can be efficient in terms of maximizing total surplus.
  • Pigovian tax/subsidy: a tax/subsidy meant to counter/capture the effect of a negative/positive externality. Government receives tax revenue.
  • Quota: limit the consumption or production of a good to its socially optimal quantity. Not efficient if given to each individual/firm without tradable allowances.
  • Tradable allowances: the right to produce or consume a product under a quota, which can be bought and sold. This allows the market to “sort itself out”. Money that would have gone to the government in the form of tax revenue goes to private parties.

Chapter 12: The Costs of Production

Costs

  • Fixed costs: costs that don’t depend on the quantity of output produced.
  • Variable costs: costs that depend on the quantity of output produced.
  • Total cost: sum of fixed costs and variable costs.
  • Explicit costs: costs that require a firm to spend money.
  • Implicit costs: costs of forgone opportunities (opportunity cost).

Production

  • Marginal product: increase in production that results from increasing the input.
  • Principle of diminishing marginal product: holding other inputs constant, the marginal product of a particular input decreases as its quantity increases.
  • Average product: number of goods produced by each worker on average.

Cost curves

  • The marginal cost curve has the inverse shape of the marginal product curve.
  • The marginal cost curve intersects the lowest point of the ATC and AVC.

Long run scale

  • Long run: the period at which a firm experiences no fixed costs.
  • Economies of scale: increasing the quantity of output enables the firm to lower its average total cost.
  • Diseconomies of scale: increasing the quantity of output increases the firm’s average total cost.
  • Constant returns to scale: many quantities of output a firm can operate in without experiencing higher or lower average cost.
  • The long-run ATC curve is made up of points from the firm’s short-run ATC curves.
  • If a firm cannot lower its average total cost by increasing or decreasing its scale, it is operating at an efficient scale.

Chapter 13: Perfect Competition

  • Characteristics of a competitive market
    • Buyers and sellers cannot affect prices (they are price-takers).
    • Goods are standardized.
    • Buyers and sellers have full information.
    • There are no transaction costs.
    • Firms can freely enter and exit.
  • In a perfectly competitive market, producers can sell as much as they want without affecting the market price.
\[\text{price} = \text{average revenue} = \text{marginal revenue}\]
  • The firm makes positive profits if the price is above the average total cost.
  • If the market price is lower than ATC but higher than AVC in the short run, the firm is making negative profits but continues to operate so it can lose the least amount possible.
  • If the market price is lower than ATC in the long run, the firm will exit.
  • In the long run, in a perfectly competitive market,
    • Firms earn zero economic profits.
    • Firms operate at an efficient scale.
    • Supply is perfectly elastic.

Chapter 14: Monopoly

  • Monopoly: a firm that faces no competition, the producer of a good or service with no close substitutes.
  • Monopoly power: the power of a monopoly that can be exercised even when a firm controls less than all of the market of a product.
  • Price discrimination: the ability to charge customers different prices for the same good.

Barriers to Entry

  • Scarce resources
  • Economies of scale (forms natural monopoly)
  • Government intervention
  • Aggressive tactics.

Monopoly Processes

  • The monopoly faces the entire demand curve for the market, and thus the demand curve slopes downwards.
  • Marginal revenue is always less than price.
  • Marginal cost is less than the price at the optimal point.
  • Monopolies can make positive economic profits in the long run because there are barriers to entry.

Problems and Solutions

  • Monopolies produce at a lower quantity and price than is efficient.
  • Responses to monopolies: antitrust laws, public ownership, regulation, vertical splits.

Chapter 15: Monopolistic Competition

  • Monopolistic competition markets: a market with many firms that sell goods & services that are similar but slightly different. Between a monopoly and perfect competition.
  • In the short run, monopolistically competitive firms behave like monopolists. In the long run, they face a perfectly competitive profit situation: profits go to zero.
    • Firms in a monopolistically competitive market must continue differentiating their product.
  • Entry-exit shifts the demand curve left or right until ATC touches the demand curve at the point where \(MR=MC\).
  • Monopolistic competition is inefficient; firms maximize profits at a price higher than marginal cost.