1. ECON 101 KONG Midterm 2 CMP Review Session

2. Benefit, Cost, Surplus – Consumers (1) A consumer benefits from the consumption of a product this benefit determines Willingness to Pay graphically represented by the Demand Curve Demand Curve: x-axis shows units of the product, i.e. quantity y-axis shows the Marginal Willingness to Pay, in $ marginal -> for 1 MORE unit, what is the max the consumer is willing to pay The more you have, the less you value a thing demand curve slops DOWN Chapter 5 Efficiency and Equity

3. Benefit, Cost, Surplus – Consumers (2) Market Demand Curve: adding up all consumers’ demand curve HORIZONTALLY Consumer Surplus: big idea: area under the demand curve = the total $ that consumers are Willing to pay for a given number of units CS = the area under the demand curve and above the price line

4. Benefit, Cost, Surplus – Producers Producer must sell to cover the cost of making a product Marginal Willingness to Sell: to deliver 1 more unit, the price producers must charge equals the cost to produce that unit = Marginal Cost graphically represented by the supply curve Market Supply Curve: adding up all suppliers’ supply curve HORIZONTALLY big idea: area underneath the supply curve = total cost of producing a given number of units Producer Surplus: area below the price line and above the supply curve

5. Efficient Market – p* & q* Equilibrium price (p*) and quantity (q*) is where market supply curve and demand curve crosses. Reasons: price > p*: producers want to sell more than consumers are willing to buy producers will drop price due to competition for customers until price = p* price < q*: consumers want to buy more than producers are willing to sell consumers bid up price until p = p*

6. Efficient Market – Total Surplus Total surplus = CS + PS CS + PS = total area under the demand curve and above the supply curve maximized when market is Efficient Deadweight Loss occurs when price ≠ p*, quantity ≠ q* when market isn’t efficient lost benefit that should have been available to society if market was Efficient … or harm done to society when more than efficient quantity is produced (wasteful use of resources)

7. Chapter 6 Government Actions KEY: don’t memorize, draw graphs Ways government can “mess with” a market Price ceiling (e.g. rent ceiling) Price floor (e.g. minimum wage) Taxes Subsidy Quota When a policy forces the market equilibrium AWAY from the efficient price and quantity, it always leads to inefficiency and DWL

8. Price Controls Price ceiling/cap: maximum price producers can charge no effect if ceiling ≥ p*, otherwise shortage occurs rent ceiling leads to less than efficient quantity of houses, longer Search Time, black market and DWL Price floor: minimum price that must be paid to producer no effect if floor ≤ p*, otherwise excess of supply minimum wage leads to unemployment (i.e. quantity of labour available in excess of the quantity demanded) effects: increased job search, DWL

9. Taxes 1.Tax on consumers, demand curve shifts down by per unit tax 2.Tax on producers, supply curve shifts up by per unit tax Big idea: consumers and producers want to be able to recreate their original condition before taxes Taxes create a NEW equilibrium that is NOT efficient Tax Incidence: how much of the tax Ultimately falls on consumers vs producers; careful! doesn’t matter who is taxed, results are the same Effect of taxes given different elasticity? Draw graphs to find out!

10. Subsidy Production quota: the max the producers can make no effect if quote ≥ q*, otherwise underproduction leads to (don’t memorize!): decrease in supply higher price lower Marginal cost company wanting to cheat and produce more than quota Production Quota Subsidy: government gives monetary aid to firms to help with production opposite of taxing the producer encourages over production and DWL

11. Chapter 10 Organizing Production Firms want to maximize Economic Profit Economic Profit: total revenue minus total cost, this is the opportunity cost of production Opportunity Cost: value of the best option NOT chosen Total cost INCLUDES Normal Profit – the amount the owner earns on average from starting a business Constraints that limit a firm’s profitability: Technology: a WAY of producing a product Information: conformation is costly Market: consumers have a limit to their budget!

12. Technologically efficient: when firm can’t produce the quality with less inputs Economically efficient: when firm can’t produce the quality at a lower cost An economically efficient method has to be technologically efficient. The relative price of inputs determines the economically efficient method Production Efficiency

13. Types of business: choices of funding 1.Sole Proprietorship: funded by ONE owner 2.Partnership: funded by TWO or MORE owners 3.Corporation: funded by a large number of owners who will not be liable to pay debt if company goes bankrupt Types of market: level of competition 1.Perfect competition: large number of firms producing identical products 2.Monopolistic competition: large number of firms producing somewhat different products 3.Oligopoly: few firms in the market 4.Monopoly: only one firm Low barrier to entry can work to keep price down! Businesses & Markets (1)

14. Types of market: level of competition 1.Four-Firm Concentration Ratio: percentage of sales accounted for by the largest 4 firms (0-100) 2.Herfindahl-Hirschman Index: sum of the percentage of sales accounted for by the largest 50 firms Careful about limitations of indexes specific to A industry Production activity of coordinated by 1.firm: lower transaction cost and economies of team production 2.market: sellers and buyers of resources uses price to coordinate production Usually a mix of the two! Businesses & Markets (2)

15. Chapter 11 Output and Costs 1.Short-Run: period of time before the firm can alter ALL factors of production 2.Long-Run: period of time after the firm CAN alter all factor of production Plant (capital) is the building / machines / big investments - usually the hardest to alter. For simplicity: long-run = after a firm can change its plant An existing plant is considered a sunk cost Sunk Cost: cost that has already been incurred and can’t be alter anymore (reduced, reclaimed, etc)

16. Short-Run Production Behaviour Product schedule Remember short run = plant doesn’t change Schedule relates total product to marginal product to average product Total Product: total output given an amount of labour Marginal Product: amount of extra output that can be achieved by using one more worker Average Product: total output divided by total labour Laws: 1.Increasing Marginal Return at the beginning due to specialization (division of labour) 2.Decreasing Marginal Return due to crowding and plant limitations

17. Costs Total Cost: cost of all factors: TC = TFC + TVC Total Fixed Cost: doesn’t vary by level of production Total Variable Cost: costs that increases or decreases as output increases or decreases – costs of labour and capital Marginal Cost: cost needed to produce 1 MORE unit Relationships between average and marginal Marginal > Average: average increase Marginal < Average: average deceases Graph tips: 1.vertical distance between ATC and AVC = the height of AFC 2.MC cuts AVC and ATC at their minimum

18. Cost curves VS Product curves Costs curves align with product curves MP going up -> MC going down AP going up -> AVC going down AP cuts MP at the output where MC cuts AVC (or the quantity where AVC is lowest) Don’t memorize! Think it through, graph on P.260

19. Long-Run Production Behaviour (1) Long-run = plant (amount of capital) can change Long-Run Production Function: shows how output varies with both labour AND capital KEY: capital also has increasing and diminishing marginal returns Long-Run Average Cost Curve: draw all the Short-Run Average Cost Curves, one for each possible plant, on the same graph trace out the lowest segments of the curves to get LRAC LRAC curve is the LOWEST average cost to produce a given a quantity when firm can alter both labour AND capital

20. Long-Run Production Behaviour (2) As output increases, firms can decrease ATC by switching to larger plants – Economies of Sale There comes a point when more output requires large plants that raises ATC due to diminishing returns from capital – Diseconomies of Scale THE output quantity in the long run when firm achieves the lowest ATC is called Minimum Efficient Scale