Sample Questions ECON 2420 Exam 1

Opportunity Cost If you win a free ticket to a movie plus all you can eat at the snack bar, is there a cost to you of going to the movie? No, because the movie is not sold out. No, because your ticket is free. Yes, because attending movies is not on a PPF. Yes, because the opportunity cost is the alternative that you give up to go to the movie. No, because your ticket and snacks are free.

Production Possibilities and Trade Identify efficient, unattainable, and inefficient points on a PPF graph How is economic growth shown on a PPF? Define absolute advantage and comparative advantage. Find comparative advantage using PPF’s for two countries. Find comparative advantage and the gains from trade from a table.

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production Possibilities Frontiers and Opportunity Costs Graphing the Production Possibilities Frontier FIGURE 2-1 BMW’s Production Possibilities Frontier

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production Possibilities Frontiers and Opportunity Costs Economic Growth FIGURE 2-3 Economic Growth Economic growth The ability of the economy to produce increasing quantities of goods and services.

Comparative Advantage and Trade Learning Objective 2.2 Comparative Advantage and Trade Absolute Advantage versus Comparative Advantage Comparative advantage The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors. Absolute advantage The 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

Comparative Advantage and Trade Learning Objective 2.2 Comparative Advantage and Trade Trade The act of buying or selling. Specialization and Gains from Trade FIGURE 2-4 Production Possibilities for You and Your Neighbor, without Trade

Solved Problem 2-2 Learning Objective 2.2 Comparative Advantage and the Gains from Trade CANADA UNITED STATES HONEY (IN TONS) MAPLE SYRUP (IN TONS) MAPLE SYRUP (IN TONS) 60 50 10 45 40 20 30 15 BEFORE TRADE AFTER TRADE HONEY (IN TONS) MAPLE SYRUP (IN TONS) MAPLE SYRUP (IN TONS) CANADA 30 15 20 UNITED STATES 10 40

Free market A market with few government restrictions on how a good or service can be produced or sold or on how a factor of production can be employed. Market economy An economy in which the decisions of households and firms interacting in markets allocate economic resources. Centrally planned economy An economy in which the government decides how economic resources will be allocated. Mixed economy An economy in which most economic decisions result from the interaction of buyers and sellers in markets, but where the government plays a significant role in the allocation of resources.

Supply and Demand What happens in the market for bicycle helmets when the price of bicycles increases? Identify a graph showing this effect. What happens in the market for women’s clothing when the wages of seamstresses increase? Identify on a graph. What happens in the market for almonds when almond harvesting productivity increases? Identify on a graph. What happens in the market for orange juice when the price of grapefruit juice, a substitute, increases?

Supply and Demand Suppliers are willing to sell another unit of a product only if The price they receive is at least equal to the cost of producing it. Consumers are willing to purchase a product up to the point where The marginal benefit of consuming the product is equal to the marginal cost (price) of consuming it.

Economic Efficiency In competitive market equilibrium The marginal benefit of the last unit sold is just equal to the marginal cost of producing it. Economic Efficiency occurs in a market outcome in which the marginal benefit to consumers of the last unit consumed is just equal to the marginal cost of production, and in which The sum of consumer and producer surplus is maximized.

Price Floors and Ceilings Identify the following on a graph of a price ceiling and/or price floor: Producer surplus Consumer surplus The deadweight loss The transfer from consumers to producers under a price floor The transfer from producers to consumers under a price ceiling

Government Intervention in the Market: Price Floors And Price Ceilings Learning Objective 4.3 Government Intervention in the Market: Price Floors And Price Ceilings Price Floors: Government Policy in Agricultural Markets FIGURE 4-8 The Economic Effect of a Price Floor in the Wheat Market

Government Intervention in the Market: Price Floors And Price Ceilings Learning Objective 4.3 Government Intervention in the Market: Price Floors And Price Ceilings Price Ceilings: Government Rent Control Policy in Housing Markets FIGURE 4-9 The Economic Effect of a Rent Ceiling

Excise Taxes Identify the following on a graph The tax revenue The “excess burden” or deadweight loss of the tax Consumer surplus after the tax Producer surplus after the tax Who bears the burden of the tax or tax incidence

The Economic Impact of Taxes Learning Objective 4.4 The Economic Impact of Taxes The Effect of Taxes on Economic Efficiency FIGURE 4-10 The Effect of a Tax on the Market for Cigarettes

Externalities An externality is Identify the following on a graph A cost or benefit experienced by someone who is not a producer or consumer of a good or service. Identify the following on a graph The private marginal cost (or supply) curve The social marginal cost (or supply) curve The private marginal benefit (or demand) curve The social marginal benefit (or demand) curve

Externalities Which of the following is a source of market failure? Incomplete property rights or an inability to enforce property rights Unforeseen circumstances that lead to bankruptcy A lack of government intervention in a market An inequitable income distribution What is a market failure? The inability of a market to allocate resources efficiently where marginal social benefit is equal to marginal social cost.

Externalities Identify on a graph The Coase theorem states that The efficient level of output for a good with a positive or negative externality The quantity by which a good with an external benefit is under-produced The quantity by which a good with an external cost is over-produced The deadweight loss due to an externality The amount of a Pigovian tax to internalize the externality The Coase theorem states that If transactions costs are low, private bargaining will result in efficient solutions to externality problems.

Externalities and Economic Efficiency Learning Objective 5.1 Externalities and Economic Efficiency The Effect of Externalities How a Negative Externality in Production Reduces Economic Efficiency FIGURE 5-1 The Effect of Pollution on Economic Efficiency

Externalities and Economic Efficiency Learning Objective 5.1 Externalities and Economic Efficiency How a Positive Externality in Consumption Reduces Economic Efficiency FIGURE 5-2 The Effect of a Positive Externality on Efficiency

Solved Problem 5-3 Learning Objective 5.3 Some toilet paper plants discharge bleach into rivers and lakes, causing substantial environmental damage. How could the federal government can use a tax on toilet paper to bring about the efficient level of production?. Using a Tax to Deal with a Negative Externality

Externalities The efficient level of pollution is that level at which The marginal benefit of pollution reduction is equal to the marginal cost of pollution reduction. One solution to the problem of external benefits or positive externalities is To subsidize the production of the good to increase its supply and reduce the price. One solution to the problem of external costs, or negative externalities, is To tax the good, reducing its supply and raising its price. What does “internalizing an external cost” mean? Making producers factor the external costs of producing their product into their (private) costs of production Taxing a good with a negative externality Forces the producer to internalize the external cost

The Economically Efficient Level of Pollution Reduction Learning Objective 5.2 The Economically Efficient Level of Pollution Reduction FIGURE 5.3 The Marginal Benefit from Pollution Reduction Should Equal the Marginal Cost

Tradable Emissions Allowances Firms will sell allowances if The cost of pollution reduction is less than the price of allowances Firms will buy allowances if The cost of pollution reduction is more than the price of allowances The net effect of tradable allowances is to Achieve a certain level of pollution reduction at lower cost

Public Goods Public goods are Non-rival and non-excludable. Common resources differ form public good in that Unlike public goods, common resources are rivalrous in consumption. A “free-rider” is Someone who benefits from a good or service without paying for it. The market demand for public goods is determined by Adding up the amount each consumer is willing to pay for each unit of the good. Private producers have no incentive to produce public goods because It is impossible to exclude those who do not pay for the good.

Four Categories of Goods Learning Objective 5.4 Four Categories of Goods FIGURE 5.8 Four Categories of Goods

Four Categories of Goods Learning Objective 5.4 Four Categories of Goods The Demand for a Public Good FIGURE 5.10 Constructing the Market Demand Curve for a Public Good