OSU Microeconomics 2001 Exam 2

the ability to produce a good at a lower opportunity cost than another producer

allows a country to specialize in products that it can produce for low costs and trade for products that are higher costs

- no international trade
- the country is closed to trade and the price paid by consumers and received by producers is the domestic
price

Mutually beneficial results for both sides; must fall between the opportunity cost of the producer and the buyer

- assumes the production and consumption of a good in the domestic economy is small relative to the global markets
- domestic production and consumption have no effect on the world market
- forces domestic prices to match world price
- country is a "price taker"

- Since domestic consumers can buy from and domestic producers can sell to the world, competition forces the actual price in the domestic market to match the world price
- Different from comparative advantage where there is complete specialization; The small-country model shows that even when a country imports a foreign good, there is often domestic production as well
- The EXPORTING country has the comparative advantage

- small-country model
- small country domestic production doesn't affect world market; they must simply "take" the price given to them

- domestic consumers pay and domestic producers receive the work price (not domestic price)
- opposite of autarkey

- (in free trade market) when world price is above domestic price, domestic producers sell more at higher price but domestic CONSUMERS buy less
- producers win

- (in free trade market) when the world price is below the domestic price, domestic consumers can by more at a lower price, but PRODUCERS sell less
- consumers win

- policy designed to reduce the competitiveness of foreign products which reduces the amount of imports
- raises price paid by consumers, wealth is reduced
- producers sell more and consumers buy less
- done for the benefit of domestic producers
- two common forms: Quotas and Tariffs

- A government tax on imported goods
- The tax raises the price of the imported good relative to the prices of domestic goods
- As the price of imported goods goes up, fewer imported goods will be purchased
- As the price of imported goods rise, that allows the price of domestic goods to rise too
- Can be useful as a retaliatory method against another country doing the same, but overall makes country WORSE OFF

- A limit on the QUANTITY of imported goods
- Raise domestic prices
- Increase domestic production
- Reduce imports
- Reduce the total amount of the product consumed
- Generates QUOTA RENT: Extra profits for the importing firm (same area as tax revenue on graph UNLESS the import is given to a foreign company, then there is no QR ; d+e+f are all deadweight losses)

- measure of sensitivity to a change
- ratio of the percentage change in a dependent variable to a percentage change in an independent variable
- e=(%change in y) /( %change in x)
- describes how much one variable will change in response to a change in another

- the percentage change in quantity demanded of a specific good or service divided by the percentage change in the price of that good or service
- deemed the most important elasticity measure by most economists

- Elastic = Greater than 1 ; the consumer changed their purchases by an amount that was relatively greater than the change in price (They were sensitive to price changes)
- Inelastic = Less than 1 ; the consumer changed their purchases by an amount that was relatively less than the change in the price (They were not sensitive to price changes)
- Unitary = Equal to 1 ; the consumer changed their purchases by a relatively equal amount to the change in the price

Perfectly elastic demand (E=∞):
- an extremely small price adjustment will create relatively massive changes in sales
- It is shown by a HORIZONTAL demand curve
Perfectly inelastic demand (E=0):
- even relatively large changes in the price have no effect on sales
- It is shown by a VERTICAL demand curve

- High end (higher price) is elastic
- Low end (lower price) is inelastic

- Revenues depend on the price elasticity of demand
- Total Revenue (TR) = P x Q

- increase in price will reduce total revenue
- decrease in price will raise total revenue

- increase in price will raise total revenue
- decrease in price will reduce total revenue

neither an increase or a decrease in price will change total revenue

1. availability of substitutes
- More substitutes = more elastic demand
2. importance of a good or service in one's budget
- Good is a large part of budget = more elastic
3. necessities vs luxuries
- Necessities = inelastic
- Luxuries = elastic
4. time
- Longer the time frame a good is being considered = becomes more elastic
- Demand curve becomes flatter over time

- measures how sensitive consumers are to changes in income
- % change in quantity demanded / % change in income

1.) Normal goods:
- Have a POSITIVE income elasticity
- When income increases, demand increases
- When income decreases, demand decreases
2.) Inferior goods
- Have a NEGATIVE income elasticity
- When income increases, demand decreases
- When income decreases, demand increases
3.) Luxury goods
- Normal goods (positive e) with an ELASTIC demand

- measure of how sensitive a product is to changes in the price of a certain good
- percentage change in quantity demanded of one good at a specific price divided by the percentage change in the price of a related good
- allows us to categorize 2 groups: substitutes and complements

indicates the products are substitutes

indicates the products are complements

- measures how sensitive producers are to changes in the price of their product
- percentage change in the quantity supplied of a good / percentage change in price
- usually positive
- can have perfectly elastic and perfectly inelastic supply curves (like elasticity demand)

- Time = key factor in determining price elasticity
- The supply curve becomes more elastic (flatter) as we
expand the time frame being used
- When one supply curve is FLATTER than another, it is more elastic****
- Supply becomes MORE elastic over time

- depends on which side of the market is more sensitive to the price increase created by the tax
- If consumers are more sensitive than producers, the producers will bear the burden of the tax
- If producers are more sensitive than consumers, the consumers will bear the burden of the tax

the satisfaction or benefit a consumer derive from using a product

number of units of utility a consumer gains from consuming a given quantity of a good in a particular time period

- the amount by which total utility rises with the consumption of an additional unit of a good
- mu= change in total utility / change in quantity

- decrease in satisfaction or usefulness from having one more unit of the same product
- Consumers will never consume a product beyond the point where MU = 0
- If the price is greater than zero, the consumer will not move beyond the point where MU = P (MU must be greater than the price of the object)
- a consumer will reach the highest TU only if the product is free (At that point the MU is zero)

- Find the MU per DOLLAR
- Divide MU by the price
- rule for optimizing purchases is to make the marginal utility per dollar of one product as nearly equal as possible with the marginal utility per dollar of a second
product while spending your entire budget

- The substitution effect of a price change changes consumption in a direction opposite to the price change
- Higher prices cause the consumer to buy less
- Lower prices cause the consumer to buy more

- How the income effect impacts the consumer depends on whether the product is a normal good or an inferior good:
Normal:
- When the product is a normal good, the effect of a price change reinforces the substitution effect
- When the product is a normal good, the demand curve is downward sloping
Inferior:
- When the product is an inferior good, the effect of a price change is to move consumption in the opposite direction
- When the product is an inferior good and the substitution effect is larger than the income effect, the demand curve is downward sloping
- When the product is an inferior good and the income effect is larger than the substitution effect, the demand curve is upward sloping

- allow us to establish a consumer's utility based on a ranking of consumer preferences
- The consumer's choices are limited by the budget they have available: PxQx + PyQy ≤ B
- Px and Py are the prices of good x and good y
- Qx and Qy are the amounts of each good the consumer can buy

firms seek to earn the greatest profit possible

revenue and costs

- payment that must be made to obtain and retain the services of a resource
- the income provided to resource owners
- the opportunity cost of using a resource
- explicit costs + implicit costs

the monetary payments a firm makes to those from who it must purchase resources that it does not own

the opportunity costs of using the resources that the firm already owns

- the difference between total revenue and explicit costs
- Accounting Profit = Total Revenue - Explicit Costs

- the difference between total revenue and economic costs
- Economic Profit = Total Revenue - Economic
Costs

- typical amount of accounting profit that you would most likely have earned in an alternative venture
- the minimum profit for a firm to earn if it is to stay in business in the long run
- $0 economic profit (breaking even)

- deals with the day to day operating decisions made by the firm
- limited by constraints that do not exist in the long run

- focuses on the strategic decisions that effect the firms capabilities in the future
- time frame in which there are no fixed inputs

- (in class) labor in capital (though you could also include land and entrepreneurship)
- capital: fixed
- labor: variable
(short run)

the quantities of output that can be obtained from different amounts of a variable factor or production, assuming other factors of production are fixed

- the average product of the workers; output per unit of
input
- Average product is calculated by dividing the total product by the quantity of workers being used to make it
- AP = TP/Q of Workers
- Hill shaped on graph because production per person begins to decline at a certain number of workers
- AP begins to fall as TP continues to rise

- measures the additional output that can be produced by using additional inputs
- CHANGE in total product/ CHANGE in quantity of workers
- TP falls with MP (dependent on MP)

- Whenever the MP is greater than the AP, the AP will rise
- And, whenever MP is less than the AP, the AP will fall
- AP = dependent variable

- all else equal, as additional units of a variable input are added to fixed inputs we will reach a point where each additional input adds less output to the total than the last
- the result of the constraint represented by the fixed inputs that cannot be changed (only true in the short run)

do not change as the level of output changes

increase as the level of production increases

- total fixed cost + total variable costs
- total cost at 0 production: NOT $0
- total cost at 0 production = FIXED costs

- total cost/quantity
- As production rises, the ATC and AVC get closer together
- become MORE important as production increases

- total fixed cost/quantity
- As production increases, AFC goes toward zero
- become LESS important as production increases

- total variable costs
- ATC = AFC + AVC

- cost of producing an additional unit of output
- change in total cost/ change in quantity
- When the only variable input is labor, MC can be found by dividing the wage by the marginal product

- The AVC is at its minimum when the MC cuts it from below
- the ATC is at its minimum when the MC cuts it from below
- Behavior of AVC and ATC (U shaped graph) is due to MC
- A company that wants to minimize its total costs will NOT minimize its marginal costs (minimizing MC only maximizes marginal production)

- the right combination of resources is when marginal product of capital/ product of capital = marginal product of labor / product of labor
- used in the long run

Marginal product of using an additional amount of that resource:
- an increase in marginal product will increase the use of the resource
The price of acquiring an additional unit of that resource:
- an increase in price will decrease the use of the resource

1. current combo of all resources used in production
2. represents what would happen if we double all inputs
3. considers tripling the original inputs
4. quadrupling all of the original inputs

- exist when a given percentage increase in all inputs leads to a greater percentage increase in the firms output
- downward sloping
- arise from specialization, mass production, and more productive equipment

- exist when a given percentage increase in all inputs leads to a smaller percentage increase in the firms output
- upward sloping on graph
- major source is difficulties with the size of large companies

- means that a given percentage increase in all inputs leads to an equal percentage increase in the firms output
- horizontal on graph

- smallest the firm can be and still operate a minimum cost in the long run
- must be at least this big to achieve maximum efficiency
- helps to explain why there are a large number of
small firms in some markets and a small number of large firms in other markets
- When the MES is small, there will be a large number of small firms
- When the MES is large, there will be small number of large firms
- The size the firm chooses depends on HOW MUCH of the product they think they can sell
- When there are large economies of scale, but a small market, the firm will choose a size that does not minimize its long-run costs