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ECON 101 KONG Midterm 2 CMP Review Session

ECON 101 KONG Midterm 2 CMP Review Session. 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 :

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ECON 101 KONG Midterm 2 CMP Review Session

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  1. ECON 101 KONGMidterm 2CMP Review Session

  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 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 Tax on consumers, demand curve shifts down by per unit tax 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. 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 • company 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

  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. Production Efficiency 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

  13. Businesses & Markets (1) Types of business: choices of funding Sole Proprietorship: funded by ONE owner Partnership: funded by TWO or MORE owners 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 Perfect competition: large number of firms producing identical products Monopolistic competition: large number of firms producing somewhat different products Oligopoly: few firms in the market Monopoly: only one firm Low barrier to entry can work to keep price down!

  14. Businesses & Markets (2) Types of market: level of competition Four-Firm Concentration Ratio: percentage of sales accounted for by the largest 4 firms(0-100) 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 firm: lower transaction cost and economies of team production market: sellers and buyers of resources uses price to coordinate production Usually a mix of the two!

  15. Chapter 11 Output and Costs • Short-Run:period of time before the firm can alter ALL factors of production • 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: • Increasing Marginal Return at the beginning due to specialization (division of labour) • 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: vertical distance between ATC and AVC = the height of AFC 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

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