ECON 2030 – Chap.

1-21/28/13 9:02 AM

​Economics:
● Economics:
o The study of how human beings coordinate their wants and
desires, given the decision- making mechanisms, social
customs and political realities of the society
o 1. What, and how much, to produce
o 2. How to produce it
o 3. For whom to produce it
o Microeconomics: the study of individual choice, and how
that choice is influenced by economic forces; economic
reasoning from the viewpoint of individuals and firms and
builds up to an analysis of the whole economy
▪ Ex: pricing policies of firms; household decisions on
what to buy; how markets allocate resources among
alternative ends
o Macroeconomics: the study of the economy as a whole;
focuses on the aggregate relationships such as how gov’t
polices can affect growth
▪ Ex: inflation; unemployment; business cycles; growth
● scarcity- the goods available are to few to satisfy individuals
desires; our wants and our means of fulfilling those wants
● Market- no a physical place; a social process; a human interaction
in which goods and services are exchanged for money
​
​Economic Reasoning:
​Opportunity Costs: the best alternative you have forgone; the best one
you didn’t choose; the benefit you might have gained from choosing the
next-best alternative
​
​ You receive benefits > your benefits cost
​ what you get what you give up
​
​Rationality: when given a choice, you will choose something if the benefits
is at least as great as the cost
​
​ Benefits > opportunity costs
​ What you get what you give up
​
​Margin: with in the choice you make, the measure of small increments of
change, that help in determining the best benefit; Refers to additional or
incremental
● Marginal cost- the additional cost to you, over and above the
costs you have already incurred, not including suck costs
● Marginal benefit- the additional benefit above what you have
already derived
 o Sunk cost- costs that have already been incurred and cannot
be recovered
​
​-Is it ever rational from an economic standpoint, to stop doing something
profitable?
● Just because it’s profitable, it doesn’t mean it’s the best thing to do
​
​Positive and Normative Economics:
● Positive Economics- the study of what is, and how the economy
works; fact based; A descriptive, factual statement about the way
the world is; A positive statement is one that is testable
● Normative Economics- the study of what the goals of the
economy should be; value based *not testable
​
​Opportunity Cost Application- CHAPTER 2
● International Trade
o If “workers in the US are the most productive in the world,”
why do we consume so many imported goods?
▪ Productivity does not matter; if it did, we wouldn’t
consume as much
▪ Gratuity cost
o If “trade can make everyone better off” why is there so much
opposition to it?
▪ Can be seen in groups/individuals that would want to
limit/exclude goods from coming in the US; what do
they all have in common
● Market: a social process; imported goods are a part of a complex
process
o Output: a result of an activity
o Input: what you put into a production process to achieve an
output
● Tools:
o Production Possibility Frontier (PPF)
▪ Production – making stuff
▪ Possibility – with what you are able to do
▪ Frontier – what is the limit/boundary (country)
▪ Illustrates the limit of your ability at a given time to
produce
▪ At any point in time we have a finite amount of
resources to utilize
🢭 Efficiency: gaining the most output, out of the
given input; achieving a goal as cheaply as
possible
🢭 Numerical slope: opportunity cost
🢭 Optimal point: macroeconomic concept
 ● Has limitations: what is optimal? Optimality
is in the eye of the users, it depends on the
consumer
​ clothes

​ food
​
​Line: PPF limit to what you are able to produce at a given time, given the
resources
● Opportunity Cost = slope of PPF
o It is possible for a point to lie inside the line, but it is not
efficient
o Any point that is efficient maybe optimal
o There are infinite combinations along the line, but only a finite
amount of quantity
o You get more from one benefit, only if you get less of another
o Principle of increasing marginal opportunity cost: in
order to get more of something one must five up
ever-increasing quantities of something else
​Purple: only needs food
​Red: only needs clothes
​Yellow, Green, Blue: has an efficient combination of needs
● A point on the PPF can move; it gives up something, to gain
another
● If the individual is producing efficiently than you are getting the
most out of your resources
​Pink: does not give up clothes for food, as it moves along the x axis
● The opportunity cost is 0
● Inefficiency: not using all resources; you gain something without
giving up anything
​Black: it is not possible to exceed the slope of PPF
● However, with possible growth points may become efficient and
possibly become inefficient
​-between Red and Green, which is better?
● Economists assume, more is better; general assumption
​-between Yellow and Green, which is better?
● The matter is dependent on the consumer
​
​How could trade make everyone better?
● If you are a country that doesn’t trade, you have to produce
everything
o Denying trade limits PPF
● Trade can allow countries to consume outside of their PPF
● Trade allows you to consume more goods than you produce
● 1.) Assumptions
o in order to have trade, you must have 2 countries, 2 different
goods
▪ these goods must be homogenous; absolutely identical,
so you only have to worry about the price
o all workers in the given country are equally productive
▪ makes opportunity cost easier to talk about
o assume that the finite amount of resources are 100
workers/hour in each country
● 2.) Relevant Concepts
o Productivity: the output of each worker with in each hour
▪ how much can be produced, by a given worker, in a
given time
🢭 productive efficiency: achieving as much
output as possible form a given amount of inputs
or resources
🢭 efficiency: achieving a goal using as few inputs
as possible
🢭 inefficiency: getting less output from inputs
that, if devoted to some other activity would
produce more output
o examples: ***PAGE 32****
▪ a meteor hits the world and destroys half the earth’s
natural resources
🢭 would cause the quantity to decrease-
▪ nanotechnology is perfected that lowers the cost of
manufactured goods
🢭 the price per good would decrease, allowing
quantity to increase- (a.
▪ A new technology is discovered that doubles the speed
at which all goods can be produced (b.
▪ Global warming increases the cost of producing
agricultural goods (
o Absolute Advantage: if it is produced at the highest level of
productivity
 ▪ goes back to the first question; US workers are the
most productive, meaning the US would have the
absolute advantage at everything
o Comparative advantage: lowest opportunity cost, giving up
the least; the ability to be better suited to the production of
one good than to the other good
▪ A country has the comparative advantage if it produces
at the lowest opportunity cost
▪ By taking advantage of each person’s comparative
advantage, the higher total output can be reached
🢭 In trade – as more and more of a good id
produced, resources that have less of a
comparative advantage are brought into the
production of a good, causing the slope of PPF to
be bowed outward
o Autarky: without trade; operating independently;
production=consumption
o Trade allows a country to consume more than its production
● If a country specializes in production and trades according to its
comparative advantage, then both countries may become better off
o This allows the country to consume more than it produces
and exceed PPF
​
​ comparative advantage example
​ Output per Worker per Hour
​

​ ​Wine ​Cloth

​England ​4 liters ​10 sq. m

​Portugal ​8 liters ​12 sq. m

​
​Productivity:
​
​ Wine: England: 4 liters/hour Portugal: 8 liters/hour
​
​Portugal has the Absolute Advantage in producing wine.
​
​ Cloth: England: 10 sq. m/hour Portugal: 12 sq. m /hour
​
​Portugal has the Absolute Advantage in producing cloth.
​
● Productivity table: 1 worker, in 1 hour can produce 4 liters
o Units must be the same with both countries
​-which country has the absolute advantage in producing wine?
● Portugal:
● Absolute advantage = highest productivity
​-Productivity is not what matters; opportunity cost is what you give up in
order to something
​-Opportunity Costs
● England: for every 1 wine it receives, they give 5/2 of cloth
o The opportunity cost of producing 1 unit of wine is 5/2 of
cloth
o To produce cloth you give up making the wine *the reciprocal
​-Which country has the comparative advantage in producing wine?
● Portugal: because they give up less cloth to make wine
● Portugal has the absolute advantage with both, but only one
comparative advantage
​-if a country specializes in what it produces most cheaply and trades with
another country that it….. ??
​
​
​
​Practice Problems:
● Chapter 1: 6-12, 16-18, 21
● Chapter 2: 1, 2, 4-8, 10
​
​QUESTIONS:
​
​1. How has the price of gasoline in the US changed over the last 40 years? Is
an example of a _________ question.
● Microeconomics or Macroeconomics
​
​2. “How have the prices of all goods and services in the US changed over the
last 40 years” is an example of a _________ question.
● Microeconomics or Macroeconomics
​
​3. Suppose Remus decides to go fishing at Lake Pescaccio on his day off
from work, but he faces a choice: he can fish the east, south, or west side of
the lake. His expected catch for the day is as follows: 5 fish on the east side,
3 fish on the south side, or 4 fish on the west side. Everything else held
constant, Remus’ opportunity cost of fishing the east side of the lake is
______ fish.
● 1? 2? 3? 4? 5? 6?
​
​4. Charles can either see Kim Carson or Beth Patterson in concert. Suppose
further that tickets to see Kim are $10 and to see Beth would be Free.
Everything else held constant, what is the opportunity cost of seeing Kim
Carson if Charles hasn’t bought a ticket yet?
● A) $10
● b) $10 + the expected pleasure of seeing Beth Patterson
● c) $10 minus the expected pleasure of seeing Beth Patterson in
concert
● d) The expected pleasure of seeing Beth Patterson in concert
● e) the expected pleasure of seeing Beth Patterson in concert minus
$10
​
​5. Suppose Meredith bought a cell phone service from a company that
charges $40/month. For that $40 she is allowed 600 minutes of free calls
and then pays 25 cents/minute for any calls above 600 minutes. Suppose
further that Meredith has used 603 minutes this month so far. Everything
else held constant, the marginal cost of the 604th minute would be what?
● A) 0 cents
● B) 25 cents
● C) 1 dollar
● D)40 dollars
● E) 41 dollars
​
​6. “students in the US who transfer from one 4 year university to another
are less likely to graduate than those who do not” is an example of a
_________ statement.
● Positive or Normative
​
​7. “the wine tasting was a perfect way to celebrate the end of an eventful
first week in Rome” is an example of a __________ statement.
● Positive or Normative
​
​1. Microeconomics
● focuses on one commodity, one good, one market
​2. Macroeconomics
​3. 4
 ● example of opportunity cost- what is the next the best alternative
​4. $10 + the expected pleasure of seeing Beth in concert
● 2 components and expected pleasure
​5. 25 cents
● what is the additional unit; she ahs to pay the 603 minutes no
matter what, the additional minute (unit) is valued at 25 cents
o marginal costs almost always deal with one unit
​6. Positive
● the statement can be tested
​7. Normative
● the statement is opinionated
​
​
opportunity cost; comparative/absolute advantage;
relevant cost 1/28/13 9:02 AM

​
​
​
​1. Given the PPF, pt. red is _________?
● Attainable
● Unattainable
​
​2. Given the PPF, pt. yellow is
● efficient
● inefficient
​
​3. Hungary is said to have the absolute advantage over Romania in
producing a good if….
● A.) Romania can produce more of the good per worker per hour
than Hungary
● B.) Hungary can produce more of the good per worker per hour
than Romania
● C.) Romania has a higher cost of producing the good than Hungary
does
● D.) Hungary has a higher cost of producing the good than Romania
does
​
​4. Romania is said to have the comparative advantage over Hungary in
producing a good if?
● A.) Romania can produce more of the good per worker per hour
than Hungary can
● B.) Hungary can produce more of the good per worker per hour
than Romania can
● C.) Romania has a higher opportunity cost of producing the good
than Hungary
● D.) Hungary has a higher opportunity cost of producing the good
than Romania
​
​ Output/Worker/Hour
​ Bagels Cookies
​Aurora 40 160
​Eos 20 200
​
​5.) Who has the absolute advantage in the production of bagels? Cookies?
Why?
​
​6.)Who has the comparative advantage in the production of bagels?
Cookies? Why?
​
​7. Travis is an art collector and reserved a painting for $400. Travis
purchased the painting. We know with certainty that the price Travis paid
for the painting was ______ $400.
● A. greater than
● B. greater than or equal to
● C. equal to
● D. less than
● E. less than or equal to
​
​ Output/Worker/Hour
​ Bread Tulips
​Bruno 5 15
​Licia 8 16
​
​8. Bruno’s opportunity cost of producing one bread is? And Licia’s
opportunity cost of producing 1 tulip?
​
​9.Who has the absolute advantage in producing bread?
​
​10. Who has the comparative advantage in producing one bread?
​
​11.Which of the following statements accurately describes the pattern of
specialization and trade in the case of Bruno and Licia?
● A.) Bruno will specialize in the production of tulips and Licia will
make bread and both will mutually benefit with trade
● B.) Bruno will make bread and Licia will make tulips and mutually
benefit from trade
● C.) Mutually beneficial trade cannot occur because Bruno can
produce more of both goods than Licia
● D.) Mutually beneficial trade cannot occur because Bruno and Licia
have the same opportunity cost of producing both goods
● E.) Mutually beneficial trade cannot occur because Licia can produce
more of both goods/worker/hour than Bruno can
​
​
​
​Answers:
​1. Attainable – it is not unattainable because the point is beyond the ability
to produce
​2. Inefficient – although the point is attainable it is inefficient because you
can have more of the good without giving up anything
​3. b.) Hungary can produce more of the good per worker per hour than
Romania
​4.) d.) comparative advantage = when a country has a lower opportunity
cost than the other country
​5.) Bagels: Aurora because productivity is higher: 40<20
​ Cookies: Eos because productivity is higher: 200<160
​6.) *Opportunity Cost (what you give up)
​ Bagels Cookies
​Aurora 160/40 40/160
​ (she gives up 4 cookies for the production of bagels) (she give up ¼ of a bagel for the production of cookies)
​Eos 200/10 20/200
​ (he gives up 10 cookies for the production of bagels) (he gives up 1/10 of a bagel for the production of cookies)
● Therefore: Aurora has the lower opportunity cost to produce bagels,
giving her the comparative advantage- 4<10; Eos has the
comparative advantage in producing bagels, because he has the
lower opportunity cost
​7.) Less than or equal to
● the buyer: maximum he is willing to spend, but not more
● the seller: he would sell for greater or equal to
​8.) Bruno: 15 tulips/5 bread = 3 tulips
​ Licia: 8 breads/16 tulips = ½ bread
​9.) Bruno: 1/3 bread Licia: ½ bread
● so Licia has the absolute advantage
​10.) Bruno: 15/3=3 bread Licia: 16/8=2 bread
● Licia has the lower opportunity cost
​
 1/28/13 9:02 AM

​Trade
● Specialization: markets that allow specialization encourage trade;
allows the country to become better at producing one good; trade
become more mutually beneficial
● When trade is allowed the slope of the combined production
possibility curve is determined by the country with the lowest
opportunity cost- by producing where costs are lowest, countries
can achieve gains from trade
​
​
​-the number of buyers: more demand = more buyers
​
​Demand – the willingness and ability to pay – the buyers side
● Refers to a schedule of quantities of a food that will be bought per
unit of time at various prices, other things held constant = how
much will be bought at various prices
● Quantity Demanded: The quantity you demand at a low price is
different from the quantity you demand at a higher price
o Rises as price falls, others things held at constant
o Falls as price rises, other things held at constant
o The change in quantity demanded shifts in movement along
the curve
● Income:
o Rise of income: increases demand for normal goods and
decreases demand for inferior goods
o Fall of income: decreases demand for normal goods and
increases demand for inferior goods
● Price of Related goods in consumption
o Substitute goods: jeans and khakis are subject to
substitute- if the price of jeans rises the demand for khakis
increases
▪ These goods are consumed in rivalry and their prices/
demands move inversely
o Complement goods: if the price of a movie ticket decreases
then the demand of popcorn increases with the demand of
movie tickets, although the price of popcorn remains
unchanged
▪ These goods are bought together; when the price of
one good declines, the demand for its complement
increases
● Tastes and Preferences: change in tastes and preferences can
cause an increase or decrease in the demand, regardless of a
change in price
● Expectations:
 o A rise of income: increases a demand for normal goods;
decreases demand for inferior goods
o If you expect the price of computers to fall, you may put off
buying one until later (WHY?)
● Taxes and Subsidies:
o Taxes imposed on goods decreases the demand
o Taxes relieved on goods increases the demand
● Changes in demand are reflected in shifts of the entire curve on a
graph
​
​-graphs are a picture of a relationship
● Q: quantity
● P: price
● A: represents a specific price and specific quantity
● B: represents another specific price and quantity
● C: represents another specific price and quantity
● As specific price goes down, quantity is demanded
● D: demand- the ability and willingness to purchase overall prices,
the entire relationship
​-Know what quantity demanded is!
​-If C changes in price, the demand does not change, but the quantity
demanded does
​
​-at any given price, if something changes and people want to buy more
​
​-Increase in demand
● an increase of income (for a normal good)
● a decrease of income (for an inferior good)
● price increased for a substitute brand
● a decrease in the price of complement
● increase in tastes/preferences
● Pe(t+1): expected price of a good in the future; an increase in the
expected price = increase in demand
o E is expected
o T is the time
o +1 makes it the future
● increase in the # of buyers
​-decrease in demand is caused by the opposite
​
​-when you want to buy something: you receive benefit, and offer giving up
something
● when buying:
o we assume the buyer is rational (rational = benefit is > cost)
o you gain worth
o reservation price: the highest price your wiling to pay
 ▪ reservation price > actual price
o benefit/worth > cost
​
​-Benefit/worth > cost
● as benefit/cost increases, you’ll do more of it
● as benefit/ cost decreases, you’ll do less of it
​
​1. determinants of ability to do a will or service
● income: demand=f(income,…)
o normal good (+): more income, demand more, regardless of
price
o inferior good (-): more income, demand less, regardless of
prices
o how people respond makes a good normal or inferior
● Prices of related goods in consumption: or/and
o Substitute goods: consumed in rivalry
o Complement goods: bought together
▪ The goods that are consumed together; if the price of
one goes up, you buy less of the other; prices move
inversely
o If the price increases, the demand of the other good will
increase: DIRECT RELATIONSHIP
● Tastes & Preferences
o Something becomes desirable; demand increases (+)
● Expectations
o The future price (+): if you expect the price to go up in the
future, you demand more today *price hasn’t changed but
perception has
o Future income: normal good (+); inferior good (-)
​
​
​---------
​Supply - Sellers – same as buying side, there is one transaction
● Supply: refers to a schedule of quantities a seller is willing and
able to sell per unit of time at various prices, everything else held
constant
o The specific price of a good does not affect the amount
supplied
o Changes in supply are reflected in an entire shift of the supply
curve
o Determinants of Supply:
▪ Cost of labor – rise in costs causes decrease supply
▪ Price of Input Costs
 🢭 Rise of input cost causes supply to fall - If cost
rise, profits will decline and firm has less incentive
to supply
▪ Productivity
🢭 Advances in technology increase supply –
advances in technology change the production
process, reducing the number of inputs needed to
produce a good = reduces the cost of production
= increases profits and leads suppliers to
increases production
▪ Price of related goods
🢭 Substitute goods: if jeans and khakis are
substitute goods, then if the cost of production in
jeans increases, the supply of khakis decreases
▪ Expectations
🢭 Future price (increase)- supplier decreases
present supply for future - If a supplier expects
an increase in the future price of her good, she
may store it now (present) in order to have
enough in the future and reap higher profits
▪ Number of sellers increases supply
▪ Taxes and Subsidies on Suppliers
🢭 Taxes on suppliers- increase cost of production
and decrease the amount supplied
🢭 Subsidies on suppliers- decrease the cost of
production and increase the amount supplied
● Quantity Supplied: the specific amount of a good/service willing
to be sold at a specific price
o The determinant of amount supplied is dependent on the
actual price
o Qs=f(p) ; as the price of a good goes up, the amount willing
and able to be sold goes up?
o quantity supplied falls as the prices falls
o quantity supplied varies directly with the price
o Determinants of Quantity Supplied:
▪ Price of a good
▪ Reservation Price
🢭 buyer: maximum price he is willing to spend, but
not more
🢭 seller: the minimum price he is willing sell for,
greater or equal to
▪ Price determines quantity supplied, just as it determines
quantity demanded
o Changes in quantity supplied are reflected in movement along
the curve
​
​
​
​Rational: you do something if the benefit is at lease as good as the cost
● Benefit > Cost
o Actual price: increases as the benefit does?
o Reservation price: for the seller is the minimum would be
willing/able to sell
 1/28/13 9:02 AM

​Expectations (for sellers)

● Future price (-)
o Wait till the price is higher, its better
​# of Sellers (+)
​
​(insert supply graph)
​Supply: the ability and willingness to sell
● All prices
o Each individual point is the amount of quantity supplied
o As the price goes up, everything else is held at constant
o What would cause supply to supply to change (increase)?
▪ Decrease in labor costs (no more benefits)
▪ Decrease in other input costs
🢭 Any cost other than the cost of labor
▪ Technology that increases worker productivity
▪ A decrease in the price of substitutes in production
▪ Expectation of future prices; if we expect the price to go
down on the future Pe(t+1)
▪ Increase in the # of sellers
o What will cause a decrease? The opposite of increase
​
​Market Equilibrium and Disequilibrium
● Equilibrium: quantity supplied = quantity demanded
o The upward pressure on a price is exactly offset by the
downward pressure on a price; there is no incentive to
change price
▪ Equilibrium quantity: the amount bought and sold at
the equilibrium price
▪ Equilibrium price: the price toward which the invisible
hand drives the market
● Excess Supply = Surplus: quantity supplied is greater than
quantity demanded
o There are more sellers, willing and able to sell than buyers,
willing and able to buy
o Price falls and quantity demanded increases in effort to move
towards equilibrium; movement in both supply and demand
● Excess Demand = Shortage: quantity demanded is greater than
the quantity supplied
o There are more buyers, wiling and able to buy, than sellers,
willing and able to sell
o Prices will rise and quantity demanded will have to fall in
effort to move towards equilibrium
● When quantity demanded is greater than quantity supplied, prices
tend to rise
 ● When quantity supplied is greater than quantity demanded, prices
tend to fall
● The greater the difference in the quantity supplied and the quantity
demanded, the more pressure there is for prices to rise and fall
● Other Forces and Equilibrium (Political and Social)
o Farmers use political pressure to obtain prices that are higher
than supply/demand equilibrium prices
o Social pressures often offset economic pressures and prevent
unemployed individuals from accepting work at lower wages
than currently employed workers receive
o Existing firms conspire to limit new competition by lobbying
Congress to pass restrictive regulations and by devising
pricing strategies to scare off new entrants
o Renters often organize to pressure local governments to set
caps on the rental price of apartments
​(insert graph)
​
​-At any moment in time, what will the price be?
● The price could be anything
● Suppose the price was high at P1- what’s the quantity demanded?
Quantity supplied?
o Buyers may not be happy paying this price, but if they are
willing and able to buy they will find a seller; but there aren’t
enough buyers to meet the quantity supplied = SURPLUS
o When there is a large surplus price goes down and quantity
demand goes up
● Where is the transaction taking place?
o A transaction must have a buyer and a seller
● At P4 the price goes down and surplus shrinks
o **as long as there is a surplus there is a force pushing the
price down
● at P3 there is equilibrium balance: no incentive to change behavior
o the quantity demanded (amount willing/able to be bought)
and quantity supplied are the same
o equilibrium -> quantity transacted
​
​(insert graph)
​- P2 price is really low; every seller can find a buyer but not all buyers can
find a seller = SHORTAGE
● backorder: more people willing and able to buy than the quantity
supplied
● as long as there is a shortage there is an incentive for buyers to
raise the price
​
​The Method
​-Who is directly affected?
● Identify if it’s the buyer or the seller
​-How does their behavior change? More or Less?
​-What is the result?
​ P*: what is the change in price?
​
​ Q*: what is the change in quantity transacted
​
​ (who) Buyer (D) Seller (S)
​ (behavior) More _ Less More _ Less
​ D+ D- S+ S-
​ P* + - - +
​ Q* + - + -
​
​-if the buyers want to buy more, start with the increase in the demand
​-buyer price = think desirability
● buyers want something if people think its desirable, the price goes
up
● if something becomes less desirable the price goes down
​-seller price = think availability
● if something becomes more available
 1/28/13 9:02 AM

​1. Suppose you observe a market in which at a given point in time the
quantity consumers are wiling and able to purchase _______ the quantity
producers are wiling and able to sell. Thuse we say there is _________ of
the good are and over time, everything else held at constant, the price in
the market will decrease.
● A.) greater than; shortage
● B.)greater than; surplus
● C.) less than; shortage
● D.) less than; surplus
​
​2. Suppose celery is a normal good. Suppose further that incomes in the
country are decreasing. Which side of the celery market is directly affected
by this decrease?
● Buyer or seller
​
​3. Suppose celery is a normal good. Suppose further that incomes in the
country are decreasing. How will buyer behavior change as a result of this
decrease?
● A.) buyers will want to buy more
● B.)buyers will want to buy less
​
​4. Suppose celery is a normal good. Suppose further that incomes in the
country are decreasing. Everything else held at constant, what will be the
result? The equilibrium price of celery will ____ and the equilibrium
transacted will ______
● a.) increase; increase
● b.) increase; decrease
● c.) decrease; increase
● d.) decrease; decrease
​
​5. Suppose that bacon and eggs are complement in consumption. Everything
else held at constant, a decrease in the price of bacon will cause _____ in
the _______ for eggs.
● A. an increase; demand for
● B. a decrease; demand for
● C. an increase; supply of
● D. a decrease; supply of
​
​6. Suppose that bacon and eggs are complement in consumption. Everything
else held at constant, a decrease in the price of bacon will cause
__________ in the equilibrium of eggs.
● A. an increase
● B. a decrease
● C. no change at all
​
​7.Suppose milk is the main input in the production of cream cheese. If the
price of milk increases, everything else held at constant, the _________
cream cheese will ___________.
● A. the supply of; increase
● B. the supply of; decrease
● C. demand for; increase
● D. demand for; decrease
​
​8. Suppose milk is the main input in the production of cream cheese. If the
price of milk increases, everything else held at constant, the equilibrium
price of cream cheese will _______ and the equilibrium quantity of cream
cheese transacted will __________.
● Increase; increase
● Increase decrease
● …
● …
​
​9. Suppose both buyers and sellers expect that the price of soup will
increase next week; this will cause the demand for soup to ________ and
the supply of it to____ TODAY, everything else held at constant
● increase; increase
● increase; decrease
● decrease; increase
● decrease; decrease
​
​10. suppose both buyers and sellers expect the price for soup to increase
next week, this will cause the price of soup to _______ and the equilibrium
quantity transacted of it to ____________ TODAY. Everything else held at
constant
● decrease; be ambiguous
● …..
● …..
● increase; ….
​
​11. Suppose that brussel sprouts are the main ingredient in a dog treat.
Suppose further that the productivity of the dog treat workers increases
while at the same time the number of buyers of dog treats doubles.
Everything else held at constant, the equilibrium price of dog treats will
________ and the equilibrium quantity of dog treats transacted will
_________
● be ambiguous; increase
● ….
● ….
● …..
​
​
​Answers
​1. d. less than; surplus
​(insert graph)
​2. Buyer
​3. Buyers will want to buy less; because celery is a normal good
​4. decrease; decrease
​(insert graph)
● who is directly affected? Buyers What will change in result?
​ Buyers
​ More _ Less
​ Demand+ Demand-
​ P* + -
​ Q* + -
​5. increase in the demand for; complement goods: if the price of good A
goes down the demand for good B goes up
​6. an increase; as the price of bacon goes down the demand for eggs goes
up & as the price of eggs goes up the demand for eggs goes down?
​7. the supply will decrease
● if costs go up, you’ll want to supply less
● who does it affect? Input costs affect sellers
● if input cost raises…. ?
​8. don’t know (insert graph)
​9. increase; decrease
​10. price-increase; quantity-ambiguous
​11.
​
Chapter 5 1/28/13 9:02 AM

​
​Markets aren’t always allowed or able to return to their equilibrium
● Caused by good and bad interferences
o Gov’t, social or other that have an affect on price controls and
quantity restrictions
● Preventing the equilibrium price and equilibrium transacted
​
​Price Controls
​
​Price Ceilings: a maximum allowable price for a good or service; does not
allow the price to rise above; gov’t imposed limit on how high a price can be
charged
● Price ceiling is used to help buyers
o Lower price means there isn’t as much to buy; some sellers
are better, but some are not = AMBIGOUS
● AMBIGOUS EFFECTS:
● For buyers as a group, some are better off and some are not
● Ex: anti price gouging law: a way to prevent prices from rising too
high, in the state of emergency
● Ex: rent control- price ceiling on rents set by the gov’t
​
​Suppose a market is at equilibrium:
● NONBINDING - A price ceiling is placed above equilibrium price
o There is no affect it its maximum price is above the
equilibrium price- allowable; buyers all have sellers and
sellers all have buyers
● NONBINDING - A price ceiling is placed at the equilibrium price
o There is no effect
● BINDING - A price ceiling is placed below the equilibrium price
o This is a problem; present price is higher than the ceiling; if
enforced the price must decrease
o As the price falls: quantity demanded increases but quantity
supplied goes down and quantity transacted goes down
● Selling a smaller number of goods or selling at lower price is bad for
business
● BINDING issues:
o lower prices – less quantity transacted
o shortage – leads to persistent shortage
​
​
​Price Floor: a minimum allowable price for a good or service; does not
allow the price to fall below; gov’t imposed limit on how low a price can be
charged
● AMBIGUOUS EFFECTS: Intended to help sellers, but only a confined
amount can find a buyer
 ● Ex: minimum wage law – laws specifying the lowest wage a firm
can legally pay an employee
● Ex: agricultural support
​
​Suppose a market is at equilibrium:
● NONBINDING - A price floor is placed below the equilibrium price
o Buyers and sellers are both happy, no reason to change the
price
● BINDING - A price floor is set above the equilibrium price
o Forces the price to increase to the minimum level
o Quantity demanded goes down and quantity supplied goes up
(more desirable to sell, at a lower price)
o Creates persistent surplus
o As price increases, the number of buyers willing and able to
buy will god down
o Supply will go up
o Quantity transacted goes down; now there are not enough
buyers
● Intended to help sellers, but only a confined amount; not all sellers
can find buyers = AMBIGOUS
​
​Quantity Restriction: a limit on the quantity of a good/service can be
transacted; limit on the number of transactions that take place; the quantity
that can be bought and sold
● Ex: gov’t put a limit on the number of items planted in a particular
crop or paying farmers not to plant a certain crop
o when a price floor is set a surplus is made
▪ *Price floor would be binding
o can’t store it, because it costs $$ to the seller (*aimed to
help the seller)
▪ Not having a surplus is more effective - because it is
cheaper to produce as well as not having to deal with
surplus
o Gov’t raises the price and pays the produced not to produce
as much
● Ex: this would be a good thing in the case of RNR – Fish
o If fish were overharvested there wouldn’t be enough left for
them to reproduce and continue populating
▪ The restriction can lead to being able to reproduce itself
and survive in the future
o Ex: Ester Island overharvested trees, and it led to lack of
source of fuel and killed off the nation
​
​Suppose a market is equilibrium
● BINDING – when quantity restriction is set below the quantity
 o This changes the shape of the supply curve; you can sell only
the limit
o Change in shortage area:
▪ The price goes up until it reaches a new equilibrium at
the demand; and there is no more shortage
▪ Quantity transacted goes down
▪ Sellers are affected ambiguously
​
​
​**Both a binding price floor and binding price ceiling will reduce the amount
of market activity; for different reasons but will have the same affect
​
​Exchange rates: price of one country’s currency in terms of another
​
​Excise tax: tax that is levied on specific good
​
​Tafiff: excise tax on imported good
​
​Third Party Payer Markets: person who receives the good differs from the
person paying for the good
● Ex: health care market – where many individuals have insurance
chap 7 1/28/13 9:02 AM

​Elasticity- the response or sensitivity to change

● Need is subjective; a taste or attitude of perception
o Need is expressed in how you respond to a change in price
(not willing and able to buy)
● Once you NEED something the buyer will do whatever necessary to
purchase
​
​Which is better as a seller?
● If you put a good on sale – demand will go up
● If you raise the price – demand goes down
● It depends:
o If a good is on sale: you will sell more, but less for every unit
▪ Ambiguous
o If the price of a good is raise: you will sell less, but more for
every
▪ Ambiguous
o GOOD/BAD – depends on the buyer and their reaction
▪ Sensitive buyer – will react to the decrease in price
▪ Insensitive buyer – will buy no matter what
​
​As a seller, raising the price is bad for your business. However, more you sell
at a higher price raises profit, but you aren’t selling as much
● On sale, you sell more but for a lower profit
​**It all depends on how sensitive buyers are to the change of price whether
or not the sellers change the price and amount of profit
​
​Price Elasticity of DEMAND- % change in quantity demanded divided by
the % change in price
● Reaction over action
● If price goes up, people will buy less – fraction is a negative number
● If ED > 1 – the price is elastic = larger reaction
● If ED < 1 – price is inelastic = smaller reaction
● If ED = 1 – the reaction is equal to the action; proportional, Unit
Elastic
● Determinants:
o Number of availability of substitutes
▪ More substitute available, means more choices; we will
go to another seller or substitute
o Necessity or luxury
▪ Is it a need or want?
o Proportion of budget spent on goods
▪ Everything else held constant, the greater proportion
spent on a particular good, the more sensitive or
insensitive you are going to be to a change in price
 🢭 Salt price increase from $1 to $1.25 = less
sensitive to action
🢭 If rent increased by 25% = more sensitive to
action
▪ *The greater your budget to spend, the more elastic
your response is
o Time
▪ Ex: your car dies- not much time to shop around
because you need a care now – you are less sensitive to
options and are inelastic
▪ Ex: You are looking for a new car within the next 2
years; you have more time and more options – you are
more sensitive and going to be elastic
​
​Sensitivity describes the behavior of a buyer and appeals to the seller
● Sellers must decide what to put on shelves, how to price, how to
appeal and how/when to change the price of a good
​
​Total Revenue – benefit to sellers from selling a good
● Total revenue = Price x Quantity
● Action = Price ; Reaction = Quantity
o If ED > 1 (elastic), increase in price leads to decreased TR
o If ED < 1 then increase in price leads to increased TR
o If ED = 1 then change of prices leads to unchanged TR
​
​Price Discrimination: charge two different customers two different prices for
exactly the same good or service
● Ex: a senior citizen receives discounts at pharmacies – OA spent a
larger proportion of budget on medication, which means they are
more sensitive to the price
o Lower price is appealing to elastic people and increases TR
o Higher price for younger adults
● Ex: Airline ticket pricing, Student Discounts, Ladies Night
​
​Price Elasticity of Supply: how sensitive sellers are
● % change in quantity supplied divided by the quantity supplied;
reaction over action
● ES > 1 price is elastic
● ES < 1 price is inelastic
● ES = 1, unit elastic
● Determinant:
o Time
▪ Longer the time to make a decision, the more time to
change behavior, supply will be more elastic
 ▪ With shorter time the supply becomes more and more
inelastic
🢭 It takes time to produce goods and services
● Graphically
o Inelastic is more vertical
o Elastic is more horizontal
​
​Classifying DEMAND & SUPPLY as elastic or inelastic
● Elastic: if percentage in quantity is greater than percentage
in change price (E >1)
● Inelastic: if percentage in quantity is less than change in
price (E<1)
​
​Elasticity and Supply & Demand Curves
● Elasticity is the not the same as slope
● Perfectly inelastic: the quantity does NOT respond at all to
changes in price (E=0)
● Perfectly elastic: quantity responds enormously to changes
in price (E=infinity)
● Unit elastic: percentage change in quantity equals change in
price (E=1)
​
​Substitution and Demand
● The number of substitutes of a good is affected by several
factors:
o Time period being considered
o Degree to which a good is a luxury
o Market Definition
o Importance of the good in one’s budget
​
​Cross Price elasticity of demand: percentage change in demand divided by
percentage change in price of a related good
● % change in demand = reaction
● % change in price of a related good = action
● if Ex>0 then substitute good
o the more positive the more substitute relationship
o goods used in place of another
● if EX<0 then complement good
o the more negative, the stronger complementary relationship
▪ put one good on sale, sell more of the complement
o goods used in conjunction with other goods
​
​Income elasticity of demand: percentage change in demand divided by
percentage change of income
● Reaction = % change in demand
● Action = % change in income
● If Ei>0 then normal goods; more positive
● If Ei<0 the inferior goods; more negative
● Normal goods: goods whose consumption increases with an
increase of income
● Luxuries: goods that have income elasticity greater than 1
● Necessity: goods that have income elasticity between 0-1
● Inferior good: goods whose consumption decreases when income
increases