ECON 101 Midterm #1 Study Package

Self Interest: Choices that are in your self - interest based on choices that you think are best for you Social Interest: Choices that are best for society as a whole, based on efficiency and equity Ex. Which one is best for social interest and self-interest if the PROF lives by the school? 1) Walk 30 mins to work <- Social interest, better for the environment, and society 2) Bike 15 mins to work 3) Car (Drive) 5 mins to work <- Self-interest, faster, convenient Economic Way of Thinking: 1) A choice is a tradeoff: giving up one thing to get something else 2) People make rational choices by comparing benefits and costs 3) Benefit is what you gain from something 4) Cost is what you must give up to get something 5) Most choices are “ how-much” choices made at the margin 6) Choices respond to incentives Choice is a tradeoff: places scarcity and implications, choice, at central stage (Parkin & Robin 2022) ● Ex. Either spending allowance money on a new jacket or a new pair of shoes Rational Choice: compares cost and benefits and achieves the greatest benefit over cost for person making choice ● The wants of a person drive the rationality of a choice ● Answers the question of what goods and services will be produced (answer: whatever people rationally choose to buy) Benefit: gain or pleasure that it brings and is determined by preferences ● Preferences: what a person likes and dislikes and intensity of those feelings Cost: something that you have to give up on Opportunity cost: the highest valued alternative that must be given up to get something Example: 1) The things you can’t afford to buy if you purchase the AC/DC tickets 2) The things you can’t do with your time if you go to the concert Marginal Benefit: To make a choice at the margin - evaluate the consequences of making incremental changes, benefit from pursuing an incremental increase in an activity ● Measured by the amount that a person is willing to pay for an additional unit of good or service (additional benefit of buying one more unit of the good or service) Marginal Cost: The opportunity cost of pursuing an incremental increase in an activity

● a is the slope of the line ( △ y / △ x) ● There is a positive relationship when the slope is positive and negative relationship when slope is negative

Chapter 2: The Economic Problem Production Possibilities and Opportunity Cost: Production Possibilities Frontier (PPF): is the boundary between goods that can be produced and goods that can’t be produced. Represented by the blue curve. ● Focus on two goods at a time, and hold the quantities of all other goods constant ● Ceteris Paribus: latin for all other things constant ● Shows the maximum combination of outputs (g/s) that can be produced with given resources and technology ● On PPF – every choice along the PPF involves a tradeoff Points on the Graph: 1) On the curve: represents a point of production efficiency 2) Inside the curve: represents points that are not efficient 3) Outside the curve: unattainable in the present Opportunity Cost: next best alternative forgone to pursue action/good – not price/$$$ with time value ● Ratio between the possible options ● As opportunity cost increases, the PPF starts to bow outward ○ As quantity produced increases, the opportunity cost increases ○ Some PPFs do not follow this rule → have a linear (straight) line meaning opportunity cost remains constant Allocative Efficiency: when we cannot produce more of one good without giving up some other good that is preferred more ● Always involves producing at a point along the PPF, so all allocatively efficient points are also production efficient ● Means the marginal benefit of producing one additional unit of a good exceeds the marginal cost in forgoing additional unit(s) of another different good Production Efficiency: any point along the PPF where all resources are being used efficiently Comparative Advantage: if one can perform the activity at a lower opportunity cost than another Absolute Advantage: if that person is more productive than another, both in terms of quantity produced and the opportunity cost from producing

7. A tradeoff exists when a. We move from a point within a PPF to a point on the PPF b. We move from a point on the PPF to a point within the PPF c. The PPF shifts towards the origin d. We move along the PPF 8. Allocative efficiency occurs when a. Opportunity costs are equal b. Goods and services produced at the lowest possible cost and are in the quantities that provide the greatest possible benefit. c. Opportunity cost is zero d. b) and c) 9. With allocative efficiency, marginal cost a. Equals marginal benefit. b. Is at its maximum. c. Equals Opportunity Cost. d. Is at its minimum. 10. What does a concave PPF demonstrate about opportunity cost? a. They are steadily decreasing as you give up one good for another b. They are steadily increasing as you give up one good for another c. They are staying the same as you give up one good for another d. Not measurable 11. What is the opportunity cost of moving away from home and going to university? a. Tuition and book costs only b. Cost of living (residence fees, food, etc.) c. Forgone salary of working full-time d. Tuition, book costs, cost of living, and forgone salary 12. If a pizza costs $12 and a hamburger cost $3, the opportunity cost of 8 hamburgers is a. 1 pizza b. 2 pizzas c. 6 hamburgers d. $24

Chapter 3: Demand and Supply Competitive Market: A market that has many buyers and many sellers so no single buyer or seller can influence the price Relative Price: The ratio of its price to the price of the next best alternative good. Contrast money price, which represents the actual monetary price of a good. Law of Demand: Ceteris Paribus , the higher the price of a good, the smaller the quantity demanded ● Demand is when a person wants a good, can afford a good, and has made a plan to purchase or acquire it ● Changes in price affect the demand because ○ Substitution Effect: When the relative price of a good/service rises, people seek substitutes, so the quantity demanded of the good/service decreases ○ Income Effect: When the price of a good rises relative to income, people cannot afford as much, so the quantity demanded of the good/service decreases ● Demand curve is a willingness-to-pay curve Demand vs. Quantity Demanded ● Demand refers to the entire relationship between price and quantity. Change in demand: Shifts the curve. ● Quantity demanded refers to the amount customers plan to buy at a certain price at a certain time. Change in quantity demanded involves moving along the demand curve. Changes in Demand Price of Related Goods Substitute: A good that can be used in place of another good (Price of Substitute ↑ then Demand of Good ↑ ) Complement: A good that can be used with another good (Price of Complement ↑ then Demand of Good ↓ ) Expected Future Prices (Future Price Expected to ↑ then Demand of Good ↑ ) (Future Price Expected to ↓ then Demand of Good ↓ ) Income Normal Good: Good that increases in demand as income increases (Income ↑ then Demand of Good ↑ ) Inferior Good: Good that decreases in demand as income increases (Income ↑ then Demand of Good ↓ ) Expected Future Income and Credit (Income Expected to ↑ then Demand ↑ ) (Income Expected to ↓ then Demand ↓ ) Population (Population ↑ then Demand ↑ ) (Population ↓ then Demand ↓ )

Effects of Change of Demand and Supply at the SAME TIME Both Demand and Supply Increase Both Demand and Supply Decrease Demand Increases and Supply Decreases Demand Decreases and Supply Increases P ? Q ↑ D ↑ S ↑ Price Uncertain because Demand Increases Price / Supply Decreases Price P ? Q ↓ D ↓ S ↓ Price Uncertain because Demand Decreases Price / Supply Increases Supply P ↑ Q ? D ↑ S ↓ Quantity Uncertain because Demand Increase Quantity / Supply Decreases Quantity P ↓ Q ? D ↓ S ↑ Quantity Uncertain because Demand Decrease Quantity / Supply Increase Quantity

9. The figure above represents the market for bubble tea. People become concerned that drinking too much bubble tea is bad for you. What happens to the equilibrium price and quantity? a. Price goes down, quantity is unknown. b. Price is unknown, quantity remains the same, c. Price goes down, quantity goes down. d. Price goes up, quantity goes down. Use the figure above to answer questions 10-13 10. The equilibrium price in the above figure is a. $25 b. $20 c. $15 d. $10 11. At a price of $kk5, there is a. A surplus of 400 units b. A shortage of 400 units c. A quantity supplied of 100 units d. An equilibrium quantity of 500 units 12. If the figure above represents an inferior good and income rises, then the equilibrium quantity will be a. Equal to 300 units b. More than 300 units c. Less than 300 units d. Inconclusive

13. If the cost of the resources used to produce the good above increases, then the equilibrium price will be a. Equal to $15 b. More than $15 c. Less than $15 d. Inconclusive

Chapter 4: Elasticity Definition of Elasticity: how responsive one factor is to other factors Independent of units of measurement and is based on ratios Price Elasticity of Demand Slope Formula: (ΔQ/Q average )/ (ΔP/P average ) or (% change in quantity demanded)/(% change in price) ● All price elasticity of demand measures will be negative because of the law of demand – price and quantity are negatively related. However, it’s the magnitude that reveals how responsive the quantity change has been to a price change What does the price elasticity mean and what does it look like? Name Description Perfectly Inelastic Demand |Ed| = 0 Quantity demanded does not react to price (ex. Insulin) Unit Elastic Demand |Ed| = 1 Quantity demanded changes at the same rate as price Perfectly Elastic Demand |Ed| = ∞ Quantity demanded reacts radically to price (ex. Soft drink from 2 campus machines located side by side) Inelastic Demand 0 < |Ed| < 1 Quantity demanded changes slower than price (ex. Food, shelter) Elastic Demand 1 < |Ed| < ∞ Quantity demanded changes faster than price (ex. Automobiles)

What makes a good’s demand elastic or inelastic? Closeness of substitutes The more substitutes a good has and the closer these substitutes are, the more elastic a good is Proportion of income The larger of a share an income’s price takes up, the more elastic a good is (for example, vacations take up a large % of a person’s income, meaning vacations are elastic) Importance of goods The less essential a good is, the more elastic it is (for example, jewelry is non-essential, so it’s elastic) Time elapsed since price change The more time customers have to react to a price change, the more elastic the good is Revenue and elasticity ● Price changes affect revenue in different ways depending on elasticity ● If the good is elastic, revenue increases as you decrease price ● If the good is inelastic, revenue increases as you increase price ● You can observe the revenue change to determine elasticity Your demand and elasticity ● If your demand is elastic, your purchase amount will increase by more than 1% with a 1% price cut ● If your demand is inelastic, your purchase amount will increase by less than 1% with a 1% price cut Income Elasticity of Demand: Measure of how quantity of good responds to change in income Formula: (ΔQ/Q average )/ (ΔI/I average ) or (% change in quantity demanded)/(% change in income) Classification of Goods ● Normal Good : If your income elasticity is greater than 0 .: the good is income elastic (greater than 1) OR income inelastic (less than 1) → increasing income also increases quantity purchased ● Inferior Good : If your income elasticity is less than 0 .: the good is inferior meaning that decreasing income increases quantity (i.e: fast food), and vice versa Cross elasticity of demand: Measure of how quantity of good demanded changes based on the price of another good Formula: (ΔQ/Q average )/ (ΔP/P average ) or (% change in quantity demanded)/(% change in other good’s price) ● If cross elasticity is greater than 0 .: the two goods are substitutes ; increase in the price of other good increases demand

● If cross elasticity is less than 0 .: the two goods are complements ; increase in the price of other good decreases demand Elasticity of supply: Measures how quantity supplied responds to price change: Formula: (ΔQ/Q average )/ (ΔP/P average ) or (% change in quantity supplied)/(% change in good’s price) ● Vertical line is non-elastic; supply is not affected by price change ● Any slanted line is unit-elastic; supply is affected by price change ● Horizontal line is infinitely elastic; decrease in price could cause cessation of supply Factors in supply elasticity ● Resource substitution → the easier it is to use the resources for the product in other products, the more supply elastic ● Time frame → the more time passes after a change in price, the more elastic the quantity supplied of a good is. ○ Momentary supply is perfectly inelastic. ○ Short-run supply is somewhat elastic. ○ Long-run supply is most elastic.

Chapter 4 Practice Questions 1. If a good’s demand curve is a horizontal line, then the good has a. Infinite price elasticity of demand b. Price elasticity of demand equal to zero c. Zero income elasticity d. Price elasticity likely to fall in short run 2. Which one of the following has the most inelastic demand? a. Apples b. Peanut butter c. Gasoline d. Insulin for a diabetic 3. The price of beef increases by 20%. Beef producers are able to increase productivity of their herds by 15%. What’s the elasticity coefficient for beef? a. 1.95 b. 0.8 c. 0.75 d. 1.44 4. Which of the following factors influences the elasticity of demand? a. Income b. Preferences c. The closeness of substitutes d. The closeness of complements 5. If a rise in price leads to a decrease in total revenue, the price elasticity of demand is a. Negative b. Zero c. Greater than zero but less than 1 d. Equal to 1 e. Greater than 1 6. When the price of good X goes up, the quantity demanded for Y goes down. Which of the following is true? a. The two goods are complementary b. The two goods are normal goods c. The cross-price elasticity coefficient is positive d. The cross-price elasticity coefficient is zero

7. An increase in demand with a highly inelastic supply will result in: a. Price falling by a lot and quantity rising by a small degree b. Price rising by a small degree and quantity rising by a lot c. Price falling by a small degree and quantity falling by a lot d. Price rising by a lot and quantity rising by a small degree 8. A shift in demand would not affect price when supply is a. Perfectly inelastic b. Unit elastic c. Perfectly elastic d. Of zero elasticity 9. When the price elasticity of demand is _____, demand for the good is perfectly inelastic. a. Equal to infinity b. Greater than 1 c. Equal to 1 d. Between 1 and zero e. Equal to zero 10. When the price elasticity of demand is _____, demand for the good is elastic. a. Equal to infinity b. Greater than 1 c. Equal to 1 d. Between zero and 1 e. Equal to zero 11. _________ indicates when the demands for two or more goods are related. a. The cross elasticity of demand b. The income elasticity of demand c. The price elasticity of demand d. The normal elasticity of demand 12. The price of product A falls from $22 to $15. During this time, product B’s quantity demanded rises from 42 to 65. Product C’s quantity demanded rises from 68 to 95. Which good is a greater compliment to product A? a. Product B b. Product C 13. Luxury goods tend to have income elasticities of demand that are a. Greater than 1 b. Greater than zero but less than 1 c. Negative

d. Less than the income elasticity of demand for normal goods 14. If good X is a complement of good Y, then the cross elasticity of demand is a. Infinity b. Positive c. Zero d. Negative 15. If good X is a substitute to good Y, then the cross elasticity of demand is a. Infinity b. Positive c. Zero d. Negative 16. Short-run supply is a. More elastic than monetary supply b. Less elastic than long-run supply c. More elastic than both monetary and long-run supply d. a) and b) 17. Long-run supply is a. Less elastic than monetary supply b. More elastic than short-run supply c. More elastic than both monetary and short-run supply d. a) and b) 18. If the supply curve passes through the origin, then the price elasticity of supply is a. Zero b. -1 c. 1 d. Greater than 0 but less than 1 e. Greater than 1 19. The price of a surfboard In Hawaii used to be $400, but recently, due to the increase of tourists, the price has increased to $450. Waterskis, which are also popular in Hawaii, their total amount sold last year was $10,000. This year stores are expecting to sell 12,000 waterskis. What is the cross Elasticity of demand for waterskis and surfboards? a. 1.54 b. 2.71 c. -2.71 d. 0.36

Chapter 5: Efficiency and Equity Resource Allocation Methods ● Allocation through market price (decentralized market planning approach): people are willing and able to buy the resource and get the resource. Consider how strongly a person wants a G/S through willingness to pay. ● Allocation via a Command System (centralized market planning approach / planned market approach): allocated by the command of someone in authority. ○ Works well in organizations when very clear lines of authority exist. ■ Difficult to execute in entire economy, when # of transactions and activities involved is large ● Allocation by Majority Rule : allocated by majority vote. ○ Works well when large # of individuals are impacted by a decision or when self-interest leads to a bad decision ● Allocation by contest : allocated to winner. ○ Works well when the efforts of “players” are hard to monitor and reward directly ● First-come, first-served allocation : allocated to those who come first in a line. ○ Works best when scarce resources can serve just 1 person at a time in sequence ● Lottery allocation : allocated to those with winning numbers, draw lucky cards, or come lucky. ○ Works well when there’s no effective way to distinguish among potential users of a scarce resource. ● Allocation according to personal characteristics : allocated to those with the “right” characteristics (e.g. kidney transplant to best suited patient). ● Allocation by force : allocated through force, like war and theft. ○ Provides an effective way of allocating resources (ex. State transfers wealth from rich to poor through forced taxes). Demand, Willingness to Pay, and Value ● Marginal Benefit: Value of one more unit of a good or service ● Value: Measured as the maximum price that a person is willing to pay ○ Willingness to pay determines demand ○ A demand curve is a marginal benefit curve

Individual Demand and Market Demand ● Individual Demand: Relationship between the price of a good and the quantity demanded by one person ● Market Demand: Relationship between the price of a good and the quantity demanded by all buyers in the market ● Market Demand Curve: Horizontal sum of individual demand curves Consumer Surplus ● Consumer Surplus: The excess of the benefit received from a good over the amount paid for it ● Calculated as the marginal benefit (or value) of a good minus its price, summed over the quantity bought ○ Measured by the area under the demand curve and above the price paid, up to the quantity bought ● E.g. When the market price is $1 ● To use consumer surplus in a practical manner, firms identify the benefit obtained by consumers, and leverage this information in defining a pricing strategy for their

goods/services. It helps firms understand net benefit/change when the price of goods/services changes. Supply, Cost, and Minimum Supply-Price ● Cost: What the producer gives up ● Price: What the producer receives ● Marginal Cost ○ Cost of one more unit of a good or service ○ Minimum price a firm is willing to accept ○ Minimum supply-price determines supply ■ A supply curve is a marginal cost curve Individual Supply and Market Supply ● Individual Supply: Relationship between the price of a good and the quantity supplied by one producer ● Market Supply: Relationship between the price of a good and the quantity supplied by all producers ● Market Supply Curve: Horizontal sum of the individual supply curves Ex. Maria and Max are the only producers of pizza.

Producer Surplus ● Producer Surplus: The excess of the amount received from the sale of a good over the cost of producing it ● Calculated as the price received for a good minus the minimum-supply price (marginal cost), summed over the quantity sold ○ Measured by the area below the market price and above the supply curve, summed over the quantity sold ○ E.g. The market price of a pizza is $15 ○ ○ Red areas show the cost of producing the pizzas sold ■ Producer surplus is the value of the pizza sold in excess of the cost of producing it ○ To use producer surplus in a practical manner, firms and governments identify the benefit obtained by engaging in market transactions to define a pricing strategy and help them understand net benefit and change when price of G/S changes. Efficiency of Competitive Equilibrium ● A competitive market creates an efficient allocation of resources at equilibrium ○ Equilibrium: quantity demanded = quantity supplied ● Resources are used efficiently when marginal social benefit (MSB) = marginal social cost (MSC) ○ Marginal Social Benefit: Society’s marginal benefit ○ Marginal Social Cost: Society’s marginal cost ● When the efficient quantity is produced, total surplus (consumer surplus + producer surplus) is maximized

○ Goods and services are produced at the lowest cost in quantities that produce the greatest value ● When Productions is ○ Less than the equilibrium quantity, MSB > MSC ○ Greater than the equilibrium quantity, MSB < MSC ○ Equal to the equilibrium quantity, MSC=MSB Market Failure ● Market Failure: When a market delivers an inefficient outcome ● Can occur because ○ Too little of an item is produced (underproduction) ○ Too much of an item is produced (overproduction) ● Results in a deadweight loss to society (decrease in total surplus)

Underproduction and Overproduction Underproduction Overproduction ● If production is restricted to an amount less than the equilibrium quantity, there is underproduction and the quantity is inefficient ● A deadweight loss equals the decrease in total surplus; the grey triangle ● This loss is a social loss ● If production is expanded to an amount greater than the equilibrium quantity, a deadweight loss arises from overproduction ● This loss is a social loss Sources of Market Failure ● In competitive markets, underproduction or overproduction arises when there are ○ Prices and quantity regulations ○ Taxes and subsidies ○ Externalities (third parties that affect the market) ○ Public goods (consumed by everyone without charge, but financed by the consumer) and common resources ○ Monopoly ○ High transactions costs Is the Competitive Market Fair? Ideas about fairness can be divided into two groups: 1. It’s Not Fair if the Results Aren’t fair ○ Utilitarianism: The idea that only equality brings efficiency ■ Should strive to achieve “the greatest happiness for the greatest number” ○ If everyone gets the same marginal utility from a given amount of income and if the marginal benefit of income decreases as income increases, then taking a dollar from a richer person and giving it to a poorer person increases the total benefit ○ Only when income equally distributed has the greatest happiness been achieved

2. It’s Not Fair if the Rules Aren’t Fair ○ Based on the symmetry principle ○ Symmetry Principle: Requirement that people in similar situations be treated similarly ○ Equality of opportunity, not equality ■ Robert Nozick suggested that fairness is based on two rules: 1. The state must create and enforce laws that establish and protect private property 2. Private property may be transferred from one person to another only by voluntary exchange ■ This means that if resources are allocated efficiently, they may also be allocated fairly

Chapter 5 Practice Questions 1. Which method of resource allocation should be used when there is no effective way to distribute scarce resources? a. Allocation via a Command System b. Allocation by force c. Allocation by Lottery d. First-come, first-served allocation 2. Which method of resource allocation is difficult to execute when there's a large number of transactions and activities involved, and doesn’t have a clear line of authority? a. Allocation via a Command System b. Allocation by market price c. Allocation by personal characteristics d. Allocation by contest 3. What is market demand? a. The average of quantity demanded of a good by all buyers in the market b. The relationship between price of a good and the quantity demanded by all buyers in the market c. The relationship between price of a good and the quantity demanded by all suppliers in the market d. The relationship between the quantity demanded by all buyers and quantity demanded by all suppliers in the market 4. Which aspect is NOT true for marginal cost? a. Cost of one more unit of good or service b. Minimum price a firm is willing to accept c. The marginal cost curve is the supply curve d. Maximum supply-price 5. What happens at market equilibrium? a. There’s deadweight loss b. The quantity demanded equals quantity supplied c. There’s more social benefit than social cost d. There’s inefficient allocation of resources 6. The restaurant sells the first hamburgers at $8, but customers are willing to pay $10. The hamburger’s marginal cost for producing the first burger is $4. What is the producer surplus on that hamburger? a. $2 b. $4

c. $10 d. $6 7. An idea of fairness that emphasizes income equality is a. Utilitarianism b. Fair opportunity c. Symmetry principle d. Fair rules 8. When does overproduction occur? a. MSB > MSC b. MSB < MSC c. MSB = MSC 9. What is the consumer surplus? a. AKMN b. RPL c. BRL d. BPL 10. A market that has low transaction costs results in a. Overproduction b. Underproduction c. Increase of tax d. Zero deadweight loss 11. Which is NOT a source of market failure? a. Price and quantity regulation b. Tax and subsidies

c. No public goods d. High transaction costs 12. What is deadweight loss? a. The decrease in total surplus b. The decrease in consumer surplus c. The decrease in producer surplus d. The increase in total surplus 13. A country taxes their wealthy class, resulting in their wealth going towards impoverished individuals in their country. This would be an example of: a. Allocation by majority rule b. Allocation by contest c. First-come, first-served allocation d. None of the above

Answer Key Chapter 1: What is Economics? 1.B 2.B 3.C 4.A 5.A 6.C 7.E 8.C 9.A 10.D 11.D 12.C Chapter 2: The Economic Problem 1.C 2.C 3.C 4.A 5.D 6.A 7.D 8.B 9.A 10.B 11.D 12.B 13.B 14.D 15.A 16.C 17.A 18.D 19.D 20.B Chapter 3: Demand and Supply 1.C 2.D 3.D 4.C 5.C 6.D 7.B 8.D 9.C 10.C 11.B 12.C 13.B Chapter 4: Elasticity 1.A 2.D 3.C 4.C 5.E 6.A 7.D 8.C 9.E 10.B 11.A 12.A 13.A 14.D 15.B 16.D 17.C 18.C 19.A Chapter 5: Efficiency and Equity 1.C 2.A 3.B 4.D 5.B 6.B 7.A 8.B 9.D 10.A 11.C 12.A 13. D