# ECON 101 KONG Midterm 2 CMP Review Session. Presented by Benji Huang

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1 ECON 101 KONG Midterm 2 CMP Review Session Presented by Benji Huang

2 Chapter 5 Efficiency and Equity 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

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 quantity 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 quantity 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 cross. 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 the efficient quantity is produced (wasteful use of resources)

7 Based on the discussions in class, argue whether a price ceiling on rent is going to help the tenants. (2 points) *short answer Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

8 Consider the market for coffees. Suppose the market demand and supply curves are as given below. Price is the price per unit in cents. Quantity refers to units of coffee per month. Demand: P = 60 4Q d Supply: P = 2Q s a. Compute the equilibrium price and quantity. (1 point) b. Now suppose the government imposes a tax of 6 cents per unit of coffee on the buyers. What is the new equilibrium price and quantity? (2 points) c. Compute the (per unit) tax burden on the consumer and producer. (1 point) *show calculation Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

9 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) Tax Subsidy Quota When a policy forces the market equilibrium AWAY from the efficient price and quantity, it always leads to inefficiency and DWL

10 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 producers 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

11 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 Tax Incidence given different elasticity? Draw graphs to find out!

12 Production Quota 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 producers wanting to cheat and produce more than quota Subsidy Subsidy: government gives monetary aid to firms to help with production opposite of taxing the producer encourages over production and DWL

13 An effective rent ceiling A) increases consumer surplus. B) increases producer surplus. C) creates a deadweight loss. D) decreases the supply of housing. E) increases the supply of housing. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

14 If the price of a good is not affected by a tax, then A) supply is perfectly elastic. B) demand is perfectly elastic. C) the elasticity of supply is greater than elasticity of demand. D) demand is unit elastic. E) supply is unit elastic. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

15 The burden of the tax on buyers is greater the more (1)elastic is demand (2)inelastic is demand (3)elastic is supply (4) inelastic is supply A) (2) only B) (1) and (3) C) (1) and (4) D) (2) and (3) E) (2) and (4) Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

16 Suppose your province raises the provincial sales tax by 1 percent. You predict that the prices of taxed goods (including the tax) will A) rise by 1 percent. B) rise by more than 1 percent. C) rise by an amount between zero and 1 percent. D) not change at all. E) fall by an amount between zero and 1 percent. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

17 The seller pays most of a tax if demand is relatively elastic because A) the buyer can easily substitute to other markets. B) the seller can easily substitute to other markets. C) the government forces the seller to bear the burden of the tax. D) there is a black market for this good. E) the seller cannot easily substitute to other goods. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

18 Chapter 10 Organizing Production Firms want to maximize Economic Profit Economic Profit: total revenue minus total cost it 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: information is costly Market: consumers have a limit to their budget!

19 Production Efficiency Technologically Efficient: when firm can t produce the quantity with less inputs Economically Efficient: when firm can t produce the quantity at a lower cost An Economically Efficient method has to be Technologically Efficient. The relative price of inputs determines the Economically Efficient method

20 Businesses & Markets (1) 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!

21 Businesses & Markets (2) 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 (0-10,000) 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!

22 Marc bought a new car last year for \$10,000. He can now sell the car for \$8,500. To buy this year's model of the same car he would have to pay \$11,000. What is the one-year amount of economic depreciation? A) \$2,500 B) \$1,500 C) \$1,000 D) \$10,000 E) \$3,500 Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

23 What is the maximum value of the Herfindahl- Hirschman Index? A) 1 B) 1,000,000 C) 100,000 D) 10,000 E) 1,000 Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

24 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 factors of production Plant (capital) is the buildings/machines- 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 (can t be reduced, reclaimed, etc) Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

25 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

26 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 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 minimums

27 Cost curves VS Product curves Costs curves match product curves: MP going up -> MC going down MP going down -> MC going up AP going up -> AVC going down AP going down -> AVC going up 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

28 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

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

30 Table above gives the supply and demand schedules for teenage labour in Genoa City. In an unregulated market, A) there is no teenage unemployment and the wage rate is \$6 per hour. B) there is no teenage unemployment and the wage rate is \$5 per hour. C) teenage unemployment is 400 hours and the wage rate is \$6 per hour. D) teenage unemployment is 400 hours and the wage rate is \$5 per hour. E) the minimum wage is \$7 per hour. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

31 Table above gives the supply and demand schedules for teenage labour in Genoa City. Suppose the Genoa City Council sets a minimum wage of \$6 per hour. Teenage unemployment is A) 800 hours. B) 600 hours. C) 400 hours. D) 200 hours. E) zero hours. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

32 If MC is rising then ATC must be A) rising. B) falling. C) above MC. D) below MC. E) none of the above. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

33 Firm A can produce a unit of output with 10 hours of labour and 5 units of capital. Firm B can produce a unit of output with 5 hours of labour and 10 units of capital. Firm C can produce a unit of output with 10 hours of labour and 10 units of capital. If the prices of labour and material are \$10 and \$5, respectively which firm is technologically efficient? A) A B) B C) C D) A and B E) A and C Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

34 Marginal product A) is always positive. B) is the slope of the total product curve. C) is always zero. D) lies between zero and one. E) equals average product minus total product. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

35 When the marginal product of labour is less than the average product of labour, A) the average product of labour is increasing. B) the marginal product of labour is increasing. C) the total product curve is negatively sloped. D) the firm is experiencing diminishing marginal returns. E) None of the above. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

36 Which one of the following statements is false? A) The average total cost curve and average variable cost curve are U-shaped. B) The gap between the average total cost curve and the average variable cost curve equals marginal cost. C) The gap between the average total cost curve and the average variable cost curve narrows as output increases. D) The marginal cost curve intersects the average variable cost curve at minimum average variable cost. E) The marginal cost curve intersects the average total cost curve at minimum average total cost. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

37 As soon as diminishing returns set in, a firm's A) marginal product increases. B) average fixed cost decreases. C) marginal cost decreases. D) marginal cost increases. E) total cost decreases. Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong

38 Explain why, for a given level of output, the average total cost in the short run cannot be lower than the average total costs in the long run. (2 points) *short answer Question taken from 2013 sample midterm 2 Reproduced with permission from Wai Ching Kong