MicroeconomicsModule 2 Study Guide Notes

It is recommended that your print and fill this study guide out as you work through each lesson. You will have an Assessment assignment that is due at the end of the module. The assessment is directly built from this study guide. In addition, each Module Study Guide can be used to prepare for the mid-term and final.

Lesson 2.1The Law of Demand

1. The market has two sides. Demand is the side of the market.

2. The states that as the price of a good rises, the quantity demanded of it falls, and that as the price of a good falls, the quantity demanded of it rises, ceteris paribus. This law holds that price and quantity demanded are related.

3. is the total number of units of a good that buyers are willing and able to buy at a particular price.

4. What is the difference between demand and quantity demanded?

5. What are the three reasons the demand curve is downward sloping or why does quantity demanded go down when price goes up and quantity demanded go up when price goes down?

a. means individuals will substitute lower priced goods for higher priced goods in order to gain utility (satisfaction).

b. means when price goes down, consumers purchasing power increase, which leads consumers to buy more.

c. means that the marginal (additional) utility or satisfaction gained by consuming equal successive units of a good will decline as each unit is consumed.

6. Identify the five factors that cause demand to shift.

7. An increase in demand = a shift in the demand curve.

8. A decrease in demand = a shift in the demand curve. Page 3 of 12

9. The only factor that can directly cause a change in the quantity demanded of a good is a change in the good's . This results is a along the curve. Draw this on the graph below. Be sure to label your axes.

10. The price of T-shirts keeps rising and rising, and people keep buying more and more. T-shirts must have an upward sloping demand curve. What is wrong with this statement?

11. A/An good is a good for which demand rises as income rises and falls as income falls. This is a/an relationship.

12. A/An good is a good for which demand falls as income rises and rises as income falls. This is a/an relationship.

13. A/An good is a good for which demand does not change as income rises or falls. This is a/an relationship.

14. are two goods that satisfy similar wants or needs. Give an example.

15. are two goods that are used jointly in consumption. Give an example.

16. Finish the following statements: a. X is a normal good: If income , then DX . If income , then DX . b. Y is an inferior good: If income , then DY . If income , then DY . c. Z is a neutral good: If income , then DZ . If income , then DZ . d. X and Y are complements: If PX , then DY . If PX , then DY . e. A and B are substitutes: If PA , then DB . If PA , then DB . f. If a preference toward Good M , then DM . If a preference toward a Good M , then Dm . g. If the number of buyers in a market for Good C, then DC . If the number of buyers in a market for Good C, then DC . h. If expectations of future prices for Good P , then DP . If expectations of future prices for Good P, then DP .

17. With respect to each of the following changes identify whether the demand curve will shift rightward or leftward. Draw each change. Scenario Demand increases or decreases? Rightward or Leftward shift in Demand Curve? Draw each curve to show the change You receive an increase in income. What happens to the demand for soda if you consider soda to be a normal good? You consider fruit loops cereal and golden grahams cereal to be substitutes. The price of fruit loops increases, what happens to the demand for golden grahams? Page 4 of 12 You receive an increase in income. What happens to the demand for hot dogs if you consider hot dogs to be an inferior good? The price of iPhones are expected to go up next month. What happens to the demand for iPhones today? You consider toothpaste to be a neutral good. What happens to the demand for toothpaste when the price rises? A major business in a city relocates causing many people to move. This reduces the number of buyers in the market. What happens to demand? You are trying to eat healthy and have sworn off fast food. What happens to the demand for fast food? You consider cereal and milk to be complements. What happens to the demand for cereal if the price of milk increases?

Lesson 2.2The Law of Supply

1. The market has two sides. Supply is the side of the market.

2. The states that as the price of a good rises, the quantity supplied of it rises, and that as the price of a good falls, the quantity supplied of it falls, ceteris paribus. This law holds that price and quantity supplied are related.

3. The does not hold when there is no time to produce more units of a good during a given period or when goods cannot be produced at all over that period.

4. is the total number of units a seller or producer are willing to sell or produce at a particular price.

5. What is the difference between supply and quantity supplied?

6. Identify the seven factors that cause supply to shift. Keep in mind that the YouTube video only shows 5 of the 7, these are the 5 most common, but there are also these two additional that can cause supply to change. Page 5 of 12

7. An increase in supply = a shift in the supply curve.

8. A decrease in supply = a shift in the supply curve.

9. The only factor that can directly cause a change in the quantity supplied of a good is a change in the good's _. This results is a along the curve. Draw this on the graph. Be sure to label your axes.

10. Finish the following statements: a. Flour is a resource used to produce bread. If PFlour , then SBread . If PFlour , then SBread . b. If there is an advance in technology in producing Good X, then SX . c. If the number of sellers for Good Y, SY . If the number of sellers for Good Y SY . d. If expectations of future prices for Good A , then SA . If expectations of future prices for Good A, then SA . e. If the government imposes or increases a tax on the production of Good Z, then then Sz . If the government lifts or decreases a tax on the production of Good Z, then SZ . f. If the government grants or increases a subsidy for the production of Good B, then SB . If the government removes or decreases a subsidy on the production of Good B, then SB . g. If the government imposes a quota on Good C, then SC . If the government lifts the quota on Good C, then SC . 11. With respect to each of the following changes identify whether the supply curve will shift rightward or leftward. Draw each change. Scenario Supply increases or decreases? Rightward or Leftward shift in Supply Curve? Draw each curve to show the change Your company produces computers. There is an increase in wage rates. What happens to the supply of computers? The government lifts a current quota on the amount of foreign coffee that can be imported into the US. What happens to the supply of foreign coffee in the US? A cheese manufacturing plant shuts down in your area. What happens to supply of cheese? The government increases the tax on every TV that is produced. What happens to the supply of TVs? Page 6 of 12 You are a farmer and you currently produce corn on your land. The price of wheat increases and you decide to produce wheat instead. What happens to the supply of corn? There is a shortage of green chili. The government offers you a $2 subsidy for every bushel of green chili you produce. What happens to the supply of green chili? The price of iPhones is expected to go up next month with the announcement of a faster network. What happens to the supply of iPhones today? The government imposes a quota on the number of foreign computers that can be imported to the US. What happens to the supply of computers in the US? Lesson 2.3Putting Supply and Demand Together 1. is the price at which quantity demanded is equal to quantity supplied. Another term for this is market-clearing price. 2. is the quantity that corresponds with the equilibrium price. It is the quantity at which the amount of the good that buyers are willing and able to buy equals the amount that sellers are willing and able to sell, and both equal the amount actually bought and sold. 3. a price other than the equilibrium price. A price at which the quantity demanded does not equal the quantity supplied. 4. is a condition in which the quantity supplied is greater than the quantity demanded. This occurs at prices the equilibrium price. 5. is a condition in which the quantity demanded is greater than the quantity supplied. This occurs at prices the equilibrium price. 6. is the state of either a surplus or a shortage. 7. means "at rest." Represents the price-quantity combination from which buyers or sellers do not tend to move away. Graphically, it is the intersection point of the and curves. 8. When a surplus exists, the market will put pressure on the price until it reaches . 9. When a shortage exists, the market will put pressure on the price until it reaches . 10. Draw a supply and demand curve below. Label the following on the graph. a. Price as Y Axis b. Quantity as X Axis c. Equilibrium d. Surplus e. Shortage f. Label equilibrium price as $10 and equilibrium quantity as 75. Page 7 of 12 Price 11. Using the graph you drew in the previous question, if price is set at $4, quantity demanded is than quantity supplied; therefore, a exists in the market. Because of this, the market will put pressure on the price. If the price is set at $12, quantity demanded is than quantity supplied; therefore, a exists in the market. Because of this, the market will put pressure on the price. Lesson 2.4Consumer and Producer Surplus 1. is the difference between the maximum price a buyer is willing and able to pay for a good or service and the price actually paid. 2. is the difference between the price sellers receive and the minimum price for which they would have sold the good. 3. is the sum of consumer surplus and producer surplus. 4. In the following graph, label supply and demand curve. Label consumer and producer surplus. Quantity 5. If the price paid for a certain good is $35 and the consumer surplus is $6, the maximum buying price for that good is . 6. If the minimum selling price is $25 and the producer surplus is $8, the price received by the seller is _. 7. The (more/less) consumer surplus that buyers receive, the better off they are. The (more/less) producer surplus that sellers receive, the better off they are. is maximized at equilibrium. 8. The demand curve for a good is downward sloping and the supply curve is upward sloping. Suppose demand rises. Will producer surplus rise or fall? Draw the graph and explain your answer. Lesson 2.5What Changes Equilibrium Price and Quantity 1. Supply and demand together determine equilibrium and equilibrium . 2. A/An _in demand is reflected in a rightward shift in the demand curve. A/An in demand is reflected in a leftward shift in the demand curve. 3. A/An _in supply is reflected in a rightward shift in the supply curve. A/An in supply is reflected in a leftward shift in the supply curve. Page 8 of 12 4. Looking at the following graphs, identify what happens to equilibrium price and quantity for each. Graph Identify if demand or supply increases, decreases, or remains constant. Identify the change in equilibrium price and quantity (increase, decreases, constant) Example D, S (if one changes more than the other, be sure to identify that. For example, D>S) P, Q Page 9 of 12 5. Complete the following steps for each graph below. a. Label price (P) and quantity (Q) axes and the supply (S) and demand (D) curves. b. Label equilibrium price as P* and equilibrium quantity as Q* c. Based on the scenario provided in each, determine which curve shifts and whether it is a rightward or a leftward shift in the curve. Draw each shift d. Identify if what happens to equilibrium price and equilibrium quantity Scenario The number of buyers in a market increases and Which curve does this affect? Is it a rightward or leftward shift? Draw the changes in either the supply curve, demand curve, or both. What happens to equilibrium Price and Quantity? supply remains constant. P Q An increase in technology occurs in the market for Good X while demand P remains unchanged. Q Page 10 o f 12 C o nsumer prefere n c e f or a p r odu c t s g oes u p while su p ply re m ains un c h a n ged. PQ T h e p r i c e o f a resou r ce nee ded t o p r o d u ce Good A d e creas e s while d e m a n d re m ains un c h a n ged. PQ T h e g overnm e n t im p oses a tax f o r p r odu cin g Good B. PQ C o nsumer i n c ome d e creases f o r a n ormal goo d a n d su p ply re m ains un c h a n ged. PQ C o nsumer prefere n ce sh i f t s toward a goo d . PQ Pr i c e o f a goo d is su p p osed t o g o u p next m o n t h so a seller h olds b a c k i nven t ory un til t he p r i c e i n creases. PQ Goo d X a n d G o o d Y are su b s t i t u tes. T h e p ric e of Goo d X i n creases a nd c h a n ges t h e d e m a n d f or Goo d Y b y m ore t han t he supply d e creases. PQ Page 10 of 12 The demand for Good Z rises by the same amount that supply for Good Z falls. P Q The demand for Good A falls less than supply falls. P Q Lesson 2.6Price and Price Controls 1. As a result of scarcity, a is needed to determine who gets what of the available limited resources and goods. serves as a rationing device. 2. acts as a transmitter of information relating to the change in the relative scarcity of a good. 3. A is a government-mandated maximum price in which legal trades cannot take place above that price. 4. A is a government-mandated minimum price in which legal trades cannot take place below that price. 5. Five effects can arise from a price ceiling that is below the equilibrium price. List those effects. 6. Two effects can arise form a price floor that that is above the equilibrium price. List those effects. 7. What is a binding price control? 8. A price ceiling that is above equilibrium price is called a price control. 9. A price ceiling that is below equilibrium price is called a price control. 10. A price floor that is above equilibrium price is called a price control. 11. A price floor that is below equilibrium price is called a price control. Page 11 of 17 12. Use the following graph to answer the questions: a. What is equilibrium price? b. What is equilibrium quantity? c. If a price ceiling is set at $0.80 is this a binding or non-binding price control? d. With a price ceiling set at $0.80, will the economy experience a surplus or shortage? e. How much? f. What effects are likely to happen due to this price ceiling? g. If a price ceiling is set at $1.60, will this hold? Why or why not? 13. Use the following graph to answer the questions: a. What is equilibrium price? b. What is equilibrium quantity? c. If a price floor is set at $2.00 is this a binding or non-binding price control? d. With a price floor at $2.00, will the economy experience a surplus or shortage? e. How much? f. What effects are likely to happen due to this price floor? g. If a price floor is set at $0.40, will this hold? Why or why not? 14. Using the following graph to answer these questions. a. If there is no price control in place, what areas represent consumer surplus? What areas represent producer surplus? b. If the government institutes a price floor above equilibrium price (PF), what areas represent the new consumer surplus? What is the losses to consumers? What areas represent the new producer surplus? What are the gains to producers? What are the losses to producers? What areas Page 12 of 17 represent the deadweight loss to society? c. is the loss to society of not producing the competitive, or the supply-anddemand determined level of output. Lesson 2.7Absolute and Relative Prices 1. The price of a good is the price of the good in terms of money. 2. The price of a good is the price of the good in terms of another good. 3. If the absolute price of Good X is $10 and the absolute price of Good Y is $14, then what is the relative price of Good X in terms of Good Y? What is the relative price of good Y in terms of Good X. Lesson 2.8 - Market Inefficiencies: Externalities & Public Goods 1. We know that buyers and sellers benefit from trade, but trade can have an effect on bystanders as well. _________________________ are the costs and benefits of a market activity that affect a bystander or third party and often lead to undesirable consequences. 2. _______________ ________________ occurs when there is an inefficient allocation of resources within a market. Externalities are a type of market failure. 3. In order for a market to work efficiently as possible, two things must occur. (1) Each person within the market must be able to evaluate _____________ costs of participation. These are costs that only the individual participant pays. (2) _________________ costs are the costs of a market activity imposed on people who are not active participants within the market. 4. _______________ costs are equal to the sum of internal costs and external costs that result from a market activity. 5. A/An _______________________ exists when an internal cost or benefit deviates from a social cost or benefit, and a _____________________ concern occurs when individuals not directly involved in a market activity experience either negative externalities or positive externalities. 6. An adverse effect on a third party is caused by a ____________________ externality; whereas a beneficial effect on a third party is caused by a _____________________ externality. 7. ____________ and _________ curves can be used to analyze the effects of externalities on the market. 8. _______________________ __________________________ is the price and quantity combination that would exist if there were no externalities. 9. Correcting for Negative Externalities: Looking at an example of an oil refinery, the supply curve represents how much the oil refinery will produce if it does not have to pay for the negative consequences of its production. In this example, the ________________________ curve accounts for only the internal or private costs of production. When a negative externality exists, the government may be able to restore _____________ ________________ by requiring the company to pay for the costs associated with their actions. To address this negative externality, the government can engage in actions that force the refinery to _________________ the externality, meaning that the refinery must take into account the external costs to society that occur as a result of their production. In this scenario, there are three potential solutions: a. The refinery can be required to change _________________ techniques or install pollution abatement equipment in order to reduce waste by products and emissions. b. The government can impose a __________ on the refinery as a means to deincentivize production. c. Government can require the refinery to pay for the ___________________ ________________ caused through production. As a result of one of these actions and having to pay the costs of imposing pollution on others, the market will result in a/an ___________________(increase/decrease) in the production (or pollution-causing activity). This will cause the supply curve to shift to the _________________. The new supply curve represents the _______________ cost + Page 13 of 17 _________________ cost. This will result in social optimum at a _______________ (higher/lower) quantity than the market equilibrium. As shown in the graph, the trade-off is clear; the negative externality can be reduced by requiring a firm to _______________________ the externality. However, the tradeoff is a lower __________________ produced and a higher _____________________. When an externality occurs, the market equilibrium creates ___________________ __________. In this case, the market is not __________________ because it is not fully capturing the cost of production. When the government intervenes and requires the firm to internalize the external costs of its production, output ___________ to the socially optimal level, and the deadweight loss from overproduction is ______________________. 10. Correcting for Positive Externalities: Looking at an example of a vaccine, supplying and demand analysis can be used to compare the efficiency of the market with the social optimum. A person who receives a flu shot gains an internal benefit or private value. Because the recipient will likely not catch the flu or become contagious, people who did not get the flu will likely be protected. Therefore, a vaccine provides a ________________ externality to the rest of society, and the internal benefit or private value is reflected in the ________________________ curve. Market ______________________ only accounts for the internal benefits of individuals who decided to get the flu shot. In order to maximize the health benefits or create ____________________ _______________, public health officials should find a way to encourage all people to consider the external benefit of the flu shot, and __________________________ the externality in order to push the market toward a socially optimum number of vaccinations. Some examples to promote this include: a. Making it mandatory for all healthcare workers to get a flu shot b. Offering a _____________, or price break, to encourage people to get vaccinated. These activities will cause the demand curve to shift to the ______________, moving the market to social ________________. The new demand curve represents the ____________ __________ + ______________________ benefit. This shift will cause a/an _______________ in quantity. Although this subsidy lowers the price to individuals, it increases the _______________ for vaccines, which raises the overall market _______________, but quantity _________________; thereby eliminated _________________ _______________ that occurs from insufficient market demand. Page 14 of 17 11. Markets do not handle externalities well. With a ____________________ externality, the market produces too much of a good; whereas with a ________________________ externality, the market produces too little of a good. In both cases, if the market creates ________________ _______________, meaning the market is not efficient because it is not fully capturing the ____________ __________ of positive externalities nor the __________________ ___________ of negative externalities. 12. Identify if each of the following examples as positive or negative externalities. Identify what is happening in the market in terms of production. Then identify the appropriate government intervention or corrective measures, identify which curve is impacted, and the likely result of the impact. The first two are filled out for you. Be able to draw the supply and demand curves in each of these scenarios and explain how social optimum is reached and how deadweight loss is eliminated. Scenario Type of Externality (Positive or Negative) Market Production occurring (overproduction or underproduction Corrective measures (taxes or subsidies) Curve affected by corrective measure Resulting impact on market quantity and price Refinery emissions create pollution Negative Overproduction Taxes Supply Q P Flu Vaccine Positive Underproduction Subsidy Demand QP Traffic congestion causes motorists to Page 15 of 17 spend more time on the road waiting Restored historic buildings enable people to enjoy architectural details Education creates a more productive workforce Smoking in public places creates increased passive smoking A rail yard creates noise pollution A farmer who grows apple trees provides a benefit to a beekeeper First-aid classes that increase job safety. 13. The presence of externalities results in a divide between the way markets operate and social optimum. This is often related to ______________ ________________, which gives an owner the ability to exercise control over a resource. When not clearly defined, resources can be mistreated. For example, the air and ocean are not owned by anyone; therefore, individuals may feel as though they can engage in pollution because there are no ________________ property rights, or an exclusive ownership that allows for the use or exchange of property. Incentives exist for establishing well-defined private property rights: a. The incentive to _____________ maintain property. b. The incentive to _____________ property. Page 16 of 17 c. The incentive to _____________ property. d. The incentive to _____________ with others. 14. Economist Ronald Coarse, introduced the _________________ ______________, which states that as long as property rights are clearly defined and transaction costs are minimal, externalities can be resolved through bargaining or negotiation. 15. A/An ______________ good is a good for which access can be limited to customer who pay for the good. A/An __________________ good is a good that can be enjoyed by one person at a time. 16. A ________________ good is one that meets the characteristics of an excludable good and a rival good in terms of consumption. A _______________________ good is one that is consumed by more than one person at a time and it is difficult to exclude nonpaying consumers from consuming it. 17. Identify each of the following goods as private or public: a. National defense _____________________________________ b. Childcare ____________________________________________ c. Laptop computer _____________________________________ d. Lighthouses __________________________________________ e. Streetlights __________________________________________ f. Automobiles _________________________________________ g. Open-source software (Chrome or Firefox) _________________ h. Microsoft Office ______________________________________ i. Taxi service __________________________________________ j. Sunset ______________________________________________ 18. Two companies: XYZ Waste Management and Slurry Corporation, both pollute a nearby river. Each firm dumps 1000 gallons of sludge into the river every day. As a consequence, the river has lost its clarity and the fish are dying. Local residents want to see the river restored, but XYZ Waste's production process depends heavily on being able to dump the sludge into the river. It would cost the firm $10 per gallon to clean up the sludge it generates. Slurry Corp can clean up its sludge at a cost of $2 per gallon. If the local government cuts the amount of sludge each firm is allowed to dump in half, what are the costs to each firm to comply with the new law? What is the total cost to both firms in meeting these emission standards? 19. This next question will require you to draw on what you have learned about supply and demand and taxes. A study finds that leaf blowers make too much noise; therefore it is considered a _____________________ externality, so the government imposes a $10 tax on the sale of every unit to correct for the social cost of the noise pollution. The tax completely internalizes the externality. Before the corrective tax, Leaves are Us Manufacturing regularly sold blowers for $100 and market quantity is 300. Draw the supply and demand curve for leaf blowers. Label the axes, the curves, market price, market quantity, and equilibrium. Which curve represents private or internal costs? _____________________________________ Which curve represents external and private costs? ________________ This is also known as _________________________ costs. What is the private market price? ____________________ What is the private market quantity? _________________ After the tax is in place, the consumer price of leaf blowers rises to $105. With this change in price, the number of leaf blowers will _____________________________________ (decrease/increase). Why will this happen? ____________ ________________________________________________ Page 17 of 17 ________________________________________________ What is the socially optimal price to the consumer? ____________________________________________ Because the firm is internalizing the externality, this will cause the supply curve to shift to the _________________ (left/right) to the socially optimal price. This results in a _____________________ (lower/higher) quantity known as the socially optimal quantity. With this being the case, what happens to the deadweight loss that occurred due to overproduction? _________________________________________________________________________ What net price is Leaves are Us receiving per leaf blower after it pays the tax? _______________________