Economics - Quiz1 Prep

Economics is the study of how society manages its scarce resources

Principles of Economic
1. Every decision involves tradeoffs



Efficiency - getting the most out of scarce resources
Equity - distributing the benefits of those resources fairly among society's members

2. The cost of something is what you give up to get something

The opportunity cost of an item is what you give up to get that item

3. Rational people think at the margin

Q. Why is water cheap while diamonds are expensive


A. Rational people think at margin. The marginal utility of diamond is more than the marginal utility of water. It does not matter much if you drink 1 unit of water or 2, but definitely an additional unit of diamond matters a lot .

4. People respond to incentives

5. Trade can make everyone better off.

6. Markets are a good way to organize economic activity

7. Governments can sometimes improve market outocmes

A market failure is a situation in which a market left on its own fails to allocate
resources efficiently

Externality : Impact of one person's action on the well being of a bystander

Public goods : Characteristics of non-excludability and non-rivalry in consumption

Market power : The ability of a single person (or small group) to unduly influence market prices

8. A country's standard of living depends on it ability to produce goods and services.

9. Prices rise when government prints too much money.

10.Society faces a short-run trade-off between inflation and unemployment

The market forces of demand and supply

Remember in the exam if nothing is mentioned, assume it is a normal good

Normal goods are those for which demand increases(decreases) when income increases(decreases)

Giffen goods do not follow law of demand , when price falls demand also falls e.g exclusive brand of liquor

Inferior goods are those where demand increases(decreases) when income decreases(increases)

Shift in the demand curve happens when non-price determinant things change


Fall in price in one good reduces the demand for another good, the two goods are substitutes.
Fall in price of one good raises the demand for another good, the two goods are compliments.

Increase in demand shifts the demand curve outwards(away from the Y-AXIS)
Decrease in demand shifts the demand curve inwards(towards the Y-AXIS)

Increase in supply shifts the supply curve outwards(towards the X-Axis)
Decrease in supply shifts the supply curve inwards(away from the X-Axis)

Q3 Page 85

a. The price of grain is kind of raw material for producing eggs. If the price of grain falls, the producers will have to bear less price to produce the eggs. So, at a given price the eggs supplied will be more, the supply curve will shift outwards reducing the equilibrium price to P2 and increasing the equilibrium quantity to Q2




b. Bacon and egg are complements. So, in this case if price of Bacon falls, demand for bacon will rise which will in turn increase the demand for eggs increasing the equilibrium price to P2 and equilibrium quantity to Q2




c. In this case the demand for egg will fall, which will shift the demand curve inwards reducing both the equilibrium price and quantity

d. In this case the supply of eggs will be reduced which will shift the supply curve inwards increasing the equivalent price and reducing the equivalent quantity.

e. The demand for egg will increase which will shift the demand curve outwards.


Elasticity and its application

Price elasticity of demand = %change in Qd/%change in P
Remember to use midpoint formula to claculate price elasticity of demand
According to this formula
e = (Q2-Q1)/[(Q2+Q1)/2]
------------------------
(P2-P1)/[(P2+P1)/2]


Determinants of Price Elasticity(very important concept)

1. Price elasticity is higher when substitutes are available
2. Price elasticity is higher for narrowly defined goods
3. Price elasticity is higher for luxuries
4. Price elasticity is higher in the long run

Rule of thumb
Flatter the curve, bigger the elasticity(memory tip: big f(l)at guy)
Steeper the curve,smaller the elasticity(memory tip, if curve is (S)teeper, elasticity is (S)maller)

e>1 - Elastic demand
e = 0 - Perfectly inelastic
e = infinity - Perfectly elastic
e= 1 - unit elastic

e= lower protion of the demand curve/upper portion of the demand curve

e= (dQ/dP)P/Q

Total revenue = P*Q
Average revenue = TR/Q = P*Q/Q = P, so AR curve is the demand curve itself
Marginal revenue = change in revenue/change in output = ΔTR/ΔQ

Remember this

1. MR is steeper than AR
2. MR is the slope of the total revenue curve
3. At maximum TR, MR is zero
4. AR and MR curve have the same vertical intercept
5. TR will increase if demand is inelastic
6. TR will decrease if demand is elastic
7. TR will remain same if demand is unitary elastic

Income elasticity = %change in Qd/%change in Income

Cross price elasticity = % change in Qd for good 1 / % change in price of good 2