ECON 323 Exam 2 (Chapters 5-7)

question

income effect

answer

the change in optimal consumption choices associated with a change in income (or purchasing power), holding preferences and relative prices constant

question

For normal goods, higher income is associated with _____________ consumption.

answer

rising

question

For inferior goods, higher income is associated with _________ consumption.

answer

falling

question

Income elasticity

answer

the % change in quantity consumed associated with a % change in income (%change in Qd/%change in I)

question

income effect equation

answer

change in Qd/change in I

question

If income elasticity is greater than zero, so that change in Q/change in I is greater than 0, the good is __________.

answer

normal

question

If income elasticity is less than zero, so that change in Q/change in I is less than 0, the good is __________.

answer

inferior

question

necessity good

answer

a normal good for which income elasticity is between zero and 1

question

With necessity goods, consumption _________ with income, but at a __________ rate. Why?

answer

rises; slower; Bc the share of the consumers budget devoted to these goods falls as income increases

question

Luxury goods

answer

normal goods with an income elasticity greater than 1

question

With luxury goods, consumption __________ with income but at a _________ rate. Why?

answer

rises; faster; bc the share of the consumers budget devoted to these goods rises as income rises

question

What is another potential way to solve for income elasticity?

answer

with the midpoint formula

question

income expansion path

answer

traces the optimal bundle of goods chosen as income increases

question

Engel curve

answer

a curve that shows the relationship between the quantity consumed of one good and a consumer's income

question

If the income expansion path is positively sloped then both goods are ____________. If it is negatively sloped, then one good is ___________.

answer

normal; inferior

question

What two things happen when the price of a good changes relative to another?

answer

1) one good becomes relatively more expensive, and the other relatively less expensive
2) the total purchasing power of a consumer's income changes

question

Substitution effect

answer

the change in consumption choices resulting from a change in relative prices

question

The substitution effect is always ___________, because?

answer

Negative, when the price of one good relative to another increases, consumption of the former falls

question

Substitution effect + income effect =

answer

Total effect

question

Tangency condition

answer

MRSxy=Px/Py or MUx/MUy=Px/Py

question

Movement from the original bundle A to the new bundle B is the?

answer

total effect, which is equal to B-A

question

Movement from the original bundle a to the substitution bundle A' is the?

answer

substitution effect, which is equal to A'-A

question

Movement from substitution bundle A' to new bundle B is the?

answer

income effect, which is equal to B-A'

question

The size of the substitution effect depends on?

answer

the curvature of indifference curves

question

Curvier indifference curve means?

answer

a smaller substitution effect because MRSxy changes a lot, which means you do not have to move far down the IC to match the slope of the BC

question

Flatter indifference curve means?

answer

larger substitution effect because MRSxy does not change much, which means you have to move further along the IC to match the slope of BC

question

The more a consumer spends on a good, the _______ they can get from trading off consumption of that good.

answer

question

The greater the amount spent on the good before the price change, the _________ the fraction of the consumer' budget affected by the price change.

answer

greater

question

Giffen goods

answer

goods for which quantity demanded increases as price rises and vice versa

question

When the price of a giffen good drops, the substitution effect is __________ than the income effect, and quantity demanded ___________. This results in a __________________ demand curve.

answer

smaller; falls; upward sloping

question

The market demand curve is found by?

answer

summing horizontally the individual demand curves

question

Final goods

answer

what is purchased by consumers

question

Intermediate goods

answer

used as inputs in other production processes

question

Production function

answer

the mathematical relationship between amount of output and various combinations of inputs

question

Assumptions about firms' production behavior:

answer

1) the firm produces a single good
2) the firm has already chosen which product to produce
3) firms minimize costs associated withe every level of production
4) only two inputs are used in production: capital and labor
5) in the short run, firms can choose the amount of labor employed, but capital is assumed to be fixed
6) output increases with inputs
7) inputs are characterized by diminishing returns
8) the firm can employ unlimited capital and labor at fixed prices
9) capital markets are well functioning (the firm is not budget-constrained)

question

Marginal product

answer

the additional output that a firm can produce using an additional unit of an input

question

Marginal product of labor

answer

change in quantity/change in labor

question

average product

answer

total output/total amount of input

question

AP of labor

answer

Q/L

question

Two benefits of the ability to change labor and capital in the long run:

answer

1) firm can lessen the effects of diminishing marginal product
2) firms can substitute between capital and labor

question

A long-run production function is a?

answer

bunch of short run production functions

question

cost minimization

answer

a firm's goal of producing a specific quantity of output at minimum cost

question

The cost minimization problem requires what two concepts?

answer

isoquants and isocost lines

question

Isoquant

answer

a curve representing combinations of inputs that allow a firm to make a particular quantity of output

question

The slope of an isoquant describes?

answer

how inputs may be substituted to produce a fixed level of output

question

Marginal Rate of Technical Substitution

answer

the rate at which a firm can substitute capital for labor and hold output constant

question

The negative slope of an isoquant is the?

answer

marginal rate of technical substitution

question

Equation of MRTSlk

answer

-change in K/change in L or MPl/MPk

question

The shape of an isoquant reveals?

answer

information about the relationship between inputs to production

question

Relatively straight isoquants imply?

answer

that inputs are relatively substitutable, which means MRtS does not vary much along the curve

question

Relatively curved isoquants imply

answer

the inputs are relatively complementary, which means MRTS varies greatly along the curve

question

isoquant maps show?

answer

how quantities of inputs are related to output produced

question

Isocost line

answer

shows all of the input combinations that yield the same cost

question

Equation of isocost line

answer

C=rK+wL

question

Slope of the isocost

answer

-w/r

question

How can we rearrange the isocost equation to graph the function?

answer

K=(C/r)+(w/r)L

question

How do firms minimize costs subject to a given amount of production?

answer

by adjusting the ratio of capital to labor

question

Graphically, cost minimization requires ______________ between the isoquant associated with the chosen level of production ad the lowest cost isocost line.

answer

tangency

question

Tangency occurs where?

answer

the slope of the isoquant is equal to the slope of the isocost (-w/r=-MPl/MPk)

question

If MPk/R > MPl/W, then...

answer

should invest in more K and fire some L because the MP per $ spent on K is greater than the MP per $ spent on L.

question

If MPk/R < MPl/W, then...

answer

Firm should hire more L and get ride of some K

question

Returns to scale

answer

the change in output when all inputs are increased in the same proportion

question

Constant returns to scale

answer

production increases proportionally to inputs (ex; double input ----> double outputs)

question

Increasing returns to scale

answer

changing all inputs by the same proportion changes output more than proportionally (ex; double inputs----> quadruple outputs)

question

decreasing returns to scale

answer

changing all inputs by the same proportion changes output less than proportionally

question

Diminishing marginal returns is a _____________ phenomenon, while returns to scale is a ______________ phenomenon.

answer

short-run; long-term

question

Why might a firm experience increasing returns to scale?

answer

-fixed costs do not vary without input
-learning by doing may occur, whereby a firm develops more efficient processes and expands or produces more input

question

When decreasing returns to scale occurs, it often results from?

answer

not accounting for all inputs

question

total factor productivity growth

answer

an improvement in technology that changes the firm's production function such that more output is obtained from the same amount of inputs

question

Expansion path

answer

a curve that illustrates how the optimal mix of inputs varies with total output

question

total cost curve

answer

shows a firm's cost of producing particular quantities

question

accounting costs

answer

include the direct costs of operating a business, including costs for raw materials

question

economic cost

answer

the sum of a producer's accounting and opportunity costs

question

opportunity cost

answer

the value of what a producer gives up by using an input

question

accounting profit

answer

A firm's total revenue minus its accounting costs

question

economic profit

answer

a firm's total revenue minus its economic costs

question

When making decisions, a business should ignore ___________.

answer

sunk costs

question

sunk costs

answer

costs that cannot be avoided because they have already been incurred

question

operating revenue

answer

the money a firm earns from selling its output

question

operating costs

answer

the cost a firm incurs in producing its output

question

sunk cost fallacy

answer

the mistake of letting sunk costs affect a firm's operating decisions

question

time horizon

answer

the chief factor determining flexibility of different input levels

question

AFC

answer

FC/Q

question

AVC

answer

VC/Q

question

ATC

answer

TC/Q or AFC+AVC

question

AFC always ____ as output rises because?

answer

falls; it is being averaged across more and more units

question

marginal cost

answer

change in total cost / change in quantity or change in VC/ change in quantity

question

When marginal cost is less than average total cost,

answer

producing another unit will reduce average cost and vice versa

question

ATC are minimized when:

answer

ATC=MC

question

AVC are minimized when:

answer

AVC=MC

question

Economies of scale

answer

cost rise more slowly than production

question

constant economies of scale

answer

costs rise at the same rate as output

question

diseconomies of scale

answer

cost rise more quickly than production

question

economies of scope

answer

the simultaneous production of multiple products at a lower cost than if a firm made each product separately

question

Why might a firm observe economies of scope?

answer

1. flexible inputs or production processes
2. expertise is translatable across several products/services

question

How do we calculate economies of scope?

answer

taking the difference between the total costs of single-good production and joint production and dividing that by the total costs of joint production.

question

What variables do we hold constant in order to isolate the income effect?

answer

the good's prices

question

Difference between substitution and income effect.

answer

The substitution effect focuses on how consumption choices change based off of the relative prices of two goods, while the income effect focuses on the change from the consumer's purchasing power

question

Isoquants farther from the origin represent higher or lower output rates?

answer

higher

question

Why can isoquants not cross?

answer

because it would imply that the same quantity of inputs yield different quantities of output

question

A nearly straight isoquant implies that the inputs are?

answer

close substitutes

question

How does technological change affect a firm's output?

answer

Technological change, A, enters the production function as a scale factor: Q=Af(K,L). This type of technological change implies that after an improvement in technology, the firm produces extra output using the same level of productive inputs prior to the change.

question

Marginal cost is dependent only on ___________ cost, not __________.

answer

variable not fixed

question

Return to scale when a+b=1

answer

Constant (input double - output double)

question

Return to scale when a + b > 1

answer

Increasing (input double - output quadruple)

question

Return to scale when a + b < 1

answer

Decreasing (double input - increase less than double of outputs)

1 of 106

question

income effect

answer

the change in optimal consumption choices associated with a change in income (or purchasing power), holding preferences and relative prices constant

question

For normal goods, higher income is associated with _____________ consumption.

answer

rising

question

For inferior goods, higher income is associated with _________ consumption.

answer

falling

question

Income elasticity

answer

the % change in quantity consumed associated with a % change in income (%change in Qd/%change in I)

question

income effect equation

answer

change in Qd/change in I

question

If income elasticity is greater than zero, so that change in Q/change in I is greater than 0, the good is __________.

answer

normal

question

If income elasticity is less than zero, so that change in Q/change in I is less than 0, the good is __________.

answer

inferior

question

necessity good

answer

a normal good for which income elasticity is between zero and 1

question

With necessity goods, consumption _________ with income, but at a __________ rate. Why?

answer

rises; slower; Bc the share of the consumers budget devoted to these goods falls as income increases

question

Luxury goods

answer

normal goods with an income elasticity greater than 1

question

With luxury goods, consumption __________ with income but at a _________ rate. Why?

answer

rises; faster; bc the share of the consumers budget devoted to these goods rises as income rises

question

What is another potential way to solve for income elasticity?

answer

with the midpoint formula

question

income expansion path

answer

traces the optimal bundle of goods chosen as income increases

question

Engel curve

answer

a curve that shows the relationship between the quantity consumed of one good and a consumer's income

question

If the income expansion path is positively sloped then both goods are ____________. If it is negatively sloped, then one good is ___________.

answer

normal; inferior

question

What two things happen when the price of a good changes relative to another?

answer

1) one good becomes relatively more expensive, and the other relatively less expensive
2) the total purchasing power of a consumer's income changes

question

Substitution effect

answer

the change in consumption choices resulting from a change in relative prices

question

The substitution effect is always ___________, because?

answer

Negative, when the price of one good relative to another increases, consumption of the former falls

question

Substitution effect + income effect =

answer

Total effect

question

Tangency condition

answer

MRSxy=Px/Py or MUx/MUy=Px/Py

question

Movement from the original bundle A to the new bundle B is the?

answer

total effect, which is equal to B-A

question

Movement from the original bundle a to the substitution bundle A' is the?

answer

substitution effect, which is equal to A'-A

question

Movement from substitution bundle A' to new bundle B is the?

answer

income effect, which is equal to B-A'

question

The size of the substitution effect depends on?

answer

the curvature of indifference curves

question

Curvier indifference curve means?

answer

a smaller substitution effect because MRSxy changes a lot, which means you do not have to move far down the IC to match the slope of the BC

question

Flatter indifference curve means?

answer

larger substitution effect because MRSxy does not change much, which means you have to move further along the IC to match the slope of BC

question

The more a consumer spends on a good, the _______ they can get from trading off consumption of that good.

answer

question

The greater the amount spent on the good before the price change, the _________ the fraction of the consumer' budget affected by the price change.

answer

greater

question

Giffen goods

answer

goods for which quantity demanded increases as price rises and vice versa

question

When the price of a giffen good drops, the substitution effect is __________ than the income effect, and quantity demanded ___________. This results in a __________________ demand curve.

answer

smaller; falls; upward sloping

question

The market demand curve is found by?

answer

summing horizontally the individual demand curves

question

Final goods

answer

what is purchased by consumers

question

Intermediate goods

answer

used as inputs in other production processes

question

Production function

answer

the mathematical relationship between amount of output and various combinations of inputs

question

Assumptions about firms' production behavior:

answer

question

Marginal product

answer

the additional output that a firm can produce using an additional unit of an input

question

Marginal product of labor

answer

change in quantity/change in labor

question

average product

answer

total output/total amount of input

question

AP of labor

answer

Q/L

question

Two benefits of the ability to change labor and capital in the long run:

answer

1) firm can lessen the effects of diminishing marginal product
2) firms can substitute between capital and labor

question

A long-run production function is a?

answer

bunch of short run production functions

question

cost minimization

answer

a firm's goal of producing a specific quantity of output at minimum cost

question

The cost minimization problem requires what two concepts?

answer

isoquants and isocost lines

question

Isoquant

answer

a curve representing combinations of inputs that allow a firm to make a particular quantity of output

question

The slope of an isoquant describes?

answer

how inputs may be substituted to produce a fixed level of output

question

Marginal Rate of Technical Substitution

answer

the rate at which a firm can substitute capital for labor and hold output constant

question

The negative slope of an isoquant is the?

answer

marginal rate of technical substitution

question

Equation of MRTSlk

answer

-change in K/change in L or MPl/MPk

question

The shape of an isoquant reveals?

answer

information about the relationship between inputs to production

question

Relatively straight isoquants imply?

answer

that inputs are relatively substitutable, which means MRtS does not vary much along the curve

question

Relatively curved isoquants imply

answer

the inputs are relatively complementary, which means MRTS varies greatly along the curve

question

isoquant maps show?

answer

how quantities of inputs are related to output produced

question

Isocost line

answer

shows all of the input combinations that yield the same cost

question

Equation of isocost line

answer

C=rK+wL

question

Slope of the isocost

answer

-w/r

question

How can we rearrange the isocost equation to graph the function?

answer

K=(C/r)+(w/r)L

question

How do firms minimize costs subject to a given amount of production?

answer

by adjusting the ratio of capital to labor

question

Graphically, cost minimization requires ______________ between the isoquant associated with the chosen level of production ad the lowest cost isocost line.

answer

tangency

question

Tangency occurs where?

answer

the slope of the isoquant is equal to the slope of the isocost (-w/r=-MPl/MPk)

question

If MPk/R > MPl/W, then...

answer

should invest in more K and fire some L because the MP per $ spent on K is greater than the MP per $ spent on L.

question

If MPk/R < MPl/W, then...

answer

Firm should hire more L and get ride of some K

question

Returns to scale

answer

the change in output when all inputs are increased in the same proportion

question

Constant returns to scale

answer

production increases proportionally to inputs (ex; double input ----> double outputs)

question

Increasing returns to scale

answer

changing all inputs by the same proportion changes output more than proportionally (ex; double inputs----> quadruple outputs)

question

decreasing returns to scale

answer

changing all inputs by the same proportion changes output less than proportionally

question

Diminishing marginal returns is a _____________ phenomenon, while returns to scale is a ______________ phenomenon.

answer

short-run; long-term

question

Why might a firm experience increasing returns to scale?

answer

-fixed costs do not vary without input
-learning by doing may occur, whereby a firm develops more efficient processes and expands or produces more input

question

When decreasing returns to scale occurs, it often results from?

answer

not accounting for all inputs

question

total factor productivity growth

answer

an improvement in technology that changes the firm's production function such that more output is obtained from the same amount of inputs

question

Expansion path

answer

a curve that illustrates how the optimal mix of inputs varies with total output

question

total cost curve

answer

shows a firm's cost of producing particular quantities

question

accounting costs

answer

include the direct costs of operating a business, including costs for raw materials

question

economic cost

answer

the sum of a producer's accounting and opportunity costs

question

opportunity cost

answer

the value of what a producer gives up by using an input

question

accounting profit

answer

A firm's total revenue minus its accounting costs

question

economic profit

answer

a firm's total revenue minus its economic costs

question

When making decisions, a business should ignore ___________.

answer

sunk costs

question

sunk costs

answer

costs that cannot be avoided because they have already been incurred

question

operating revenue

answer

the money a firm earns from selling its output

question

operating costs

answer

the cost a firm incurs in producing its output

question

sunk cost fallacy

answer

the mistake of letting sunk costs affect a firm's operating decisions

question

time horizon

answer

the chief factor determining flexibility of different input levels

question

AFC

answer

FC/Q

question

AVC

answer

VC/Q

question

ATC

answer

TC/Q or AFC+AVC

question

AFC always ____ as output rises because?

answer

falls; it is being averaged across more and more units

question

marginal cost

answer

change in total cost / change in quantity or change in VC/ change in quantity

question

When marginal cost is less than average total cost,

answer

producing another unit will reduce average cost and vice versa

question

ATC are minimized when:

answer

ATC=MC

question

AVC are minimized when:

answer

AVC=MC

question

Economies of scale

answer

cost rise more slowly than production

question

constant economies of scale

answer

costs rise at the same rate as output

question

diseconomies of scale

answer

cost rise more quickly than production

question

economies of scope

answer

the simultaneous production of multiple products at a lower cost than if a firm made each product separately

question

Why might a firm observe economies of scope?

answer

1. flexible inputs or production processes
2. expertise is translatable across several products/services

question

How do we calculate economies of scope?

answer

taking the difference between the total costs of single-good production and joint production and dividing that by the total costs of joint production.

question

What variables do we hold constant in order to isolate the income effect?

answer

the good's prices

question

Difference between substitution and income effect.

answer

The substitution effect focuses on how consumption choices change based off of the relative prices of two goods, while the income effect focuses on the change from the consumer's purchasing power

question

Isoquants farther from the origin represent higher or lower output rates?

answer

higher

question

Why can isoquants not cross?

answer

because it would imply that the same quantity of inputs yield different quantities of output

question

A nearly straight isoquant implies that the inputs are?

answer

close substitutes

question

How does technological change affect a firm's output?

answer

question

Marginal cost is dependent only on ___________ cost, not __________.

answer

variable not fixed

question

Return to scale when a+b=1

answer

Constant (input double - output double)

question

Return to scale when a + b > 1

answer

Increasing (input double - output quadruple)

question

Return to scale when a + b < 1

answer

Decreasing (double input - increase less than double of outputs)

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