Dr. Duffy Microeconomics

1. Dr. Duffy Microeconomics Exam 1 review CHAPTERS 1-3 Frank and Bernanke

2. Exam Format & Rules • 35 multiple choice, 2 points each • 30 points for short problems, similar to homework problems • You do not need a Scantron • You may use a calculator but Andrew or I must check it first. It can't have a memory function. It must be a simple calculator, not a scientific or business calculator. • No cell phones on desks. • We must be able to see your ears at all times.

3. Major Concepts • Opportunity Costs • Sunk Costs • Marginal and Average Benefit • Marginal and Average Cost • Cost-Benefit Principle • Scarcity Principle • "Low Hanging Fruit" (e.g. increased opportunity costs to produce more of a product) • Comparative versus Absolute Advantage • PPF • Exchange • Supply and Demand • Equilibrium, Surplus, Shortage

4. Sunk Cost Problem Sunk Cost Problem: I purchased a computer in 2006 for $2,000 and it now has a retail value of $500. How much is the sunk cost? (Cost I can't recover.) Sunk cost = $2000-$500 = $1500.

5. Opportunity Cost Problem Jane has a voucher, good for one domestic airfare, that must be used by January 10, 2008. She could use the voucher to attend a friend's wedding in October, or save it to use to go home in December (a trip she must make.) She values attending the wedding at $800. Airfare to the wedding, if she buys it, is $400 and all other costs would equal $600. Her airfare home in December would cost $300. Should she attend the wedding? No. Benefit: $800 Cost: $600 + $300 = $900 (with voucher) $600 + $400 = $1000 (without)

6. Opportunity Cost Problem, revisited Jane has a voucher, good for one domestic airfare, that must be used by January 10, 2008. She could use the voucher to attend a friend's wedding in October, or save it to use to go home in December (a trip she must make.) She values attending the wedding at $1200. Airfare to the wedding, if she buys it, is $400 and all other costs would equal $600. Her airfare home in December would cost $300. Yes. Benefit: $1200 Cost: $600 + $300 = $900 (with voucher) $600 + $400 = $1000 (without) She will use the voucher for the wedding because the flight home is cheaper than the flight to the wedding.

7. Comparative Advantage In one hour, Chris can knit six hats or sew three shirts. In one hour, John can knit five hats or sew two shirts. Who has the comparative advantage at hats? At shirts?

8. Comparative Advantage In one hour, Chris can knit six hats or sew three shirts. In one hour, John can knit five hats or sew two shirts. Chris gives up 2 hats for every shirt. John gives up 2.5 hats for every shirt. Chris has the comparative advantage at shirts (lower opportunity cost). John must have the comparative advantage for hats. Chris has the absolute advantage for both.

9. Trade Chris gives up two hats for every shirt. He would be willing to trade a shirt for 2 or more hats. John would be willing to pay no more than 2.5 hats (his opportunity cost) to get a shirt. Trade could take place at a rate between 2 and 2.5 hats per shirt.

10. Fallacies • Angie is happy to get a $2.00 discount on a $10 item, but spurns a $5.00 discount on a $1000 item. • Bob believes that by going to the dentist twice a year, he is preventing $5000 worth of dental work in the future. He reasons that if he goes four times per year, he will prevent $10,000 of future work.

11. Fallacies • Jill spent 10 hours in line to get a ticket to see a rock concert. She paid $40 cash and tells everyone that is her full cost of the ticket. • Bill spent $20 (non-refundable) to hire a tennis pro for Friday afternoon. But he finds out he has the opportunity to get free tutoring that afternoon. He values the free tutoring at $50, but won't get tutoring because he has already paid for the tennis pro's time.

12. What happened? • The price of tomatoes has gone up and the quantity sold has fallen. • The price of TVs has fallen and the quantity sold has increased. • The price of CDs has fallen and so has the amount sold. • The price of beef has increased and so has the amount sold.

13. What will happen to price and quantity? • A drought hits the Southeast, damaging the peach crop. • Grapes are a substitute in consumption for peaches. What happens in that market? • The health benefits of corn are announced in the news. What happens to corn prices and quantity sold? • Corn is used in chicken feed (an input in production). What happens in this market?

14. Surplus: Which if the following will cause a surplus of tuna? • Demand for tuna decreases because of news about mercury levels. • Supply of tuna increases because of better fishing measures. • The government regulates the price of tuna and sets it above market equilibrium. • The government regulates the price of tuna and sets it below market equilibrium.

15. Shortage: Which if the following will cause a shortage of gasoline? • Demand for gasoline increases because people are commuting longer distances. • Supply of gasoline decreases because of trouble in the Middle East. • The government regulates the price of gasoline and sets it above market equilibrium. • The government regulates the price of gasoline and sets it below market equilibrium.

16. Moving two curves at the same time. Assume the demand for corn increases, and the supply also decreases. What will happen to price? Quantity? Draw a graph and see what you find out. Draw different magnitudes of the two shifts and see if anything is consistent.

17. Moving two curves at once. • If demand increases and supply increases at the same time, we know for certainty that quantity will increase. • If demand increases and supply decreases, we know for certainty that price will increase. • If demand decreases and supply decreases, we know for certainty that quantity will decrease. • If demand decreases and supply increases, we know for certainty that price will decrease.