Exam 1

Question 1

What is economic profit?

Answer 1

The difference between total revenue and total opportunity cost.

Question 2

What is the importance of incentives?

Answer 2

All other things held constant, people are more likely to do something that has an incentive attached to it. Incentives affect how resources are used and how hard workers work.

Question 3

What is marginal benefit?

Answer 3

The additional benefit that arise by using an additional unit of the item.

Question 4

What is marginal cost?

Answer 4

The additional cost incurred by using an additional unit of the item.

Question 5

What is the formula for the Present Value of a lump-sum future amount?

Answer 5

PV = FV/(1+i)^n

Question 6

What is the formula for the Present value of a stream of future amounts?

Answer 6

PV = (FV/(1+i)^1) + (FV2/(1+i)^2) + … + FV/(1+i)^n

Question 7

What is the formula for Present value of a perpetuity?

Answer 7

PV = [CF/(1+i)] + [CF/(1+i)^2] + [CF/(1+i)^3] + …
OR
PV = CF/i

Question 8

What is a normal good?

Answer 8

A good for which an increase (decrease) in income leads to an increase (decrease) in the demand for that good.

Question 9

What is an inferior good?

Answer 9

A good for which an increase (decrease) in income leads to a decrease (increase) in the demand for that good.

Question 10

What is a substitute good?

Answer 10

Goods for which an increase (decrease) in the price of one good leads to an increase (decrease) in the demand for the other good.

Question 11

What is a complement good?

Answer 11

Goods for which an increase (decrease in the price of one good leads to a decrease (increase) in the demand for the other good.

Question 12

What is the formula for the inverse demand function?

Answer 12

Px = (Qdx - A)/alpha x

Question 13

What is the formula for the inverse supply function?

Answer 13

Px = (Qsx - beta)/beta x

Question 14

In the demand function, what is the test for substitute/complement?

Answer 14

alpha y >0 - substitute

alpha y <0 - complement

Question 15

In the demand function, what is the test for normal/inferior good?

Answer 15

alpha m > 0 normal good

alpha m < 0 inferior good

Question 16

In the demand function, what does alpha x indicate?

Answer 16

If alpha x is negative, then an increase in price will decrease quantity demanded.

Question 17

What is consumer surplus?

Answer 17

The value consumers get from a good but don’t have to pay for it.

Question 18

What is producer surplus?

Answer 18

The amount of producers receive in excess of the amount necessary to induce them to produce the good.

Question 19

What is a price ceiling?

Answer 19

The maximum legal price that can be charged in a market.

Question 20

What is own price elasticity?

Answer 20

A measure of the responsiveness of the quantity demanded of a good to a change in the price of that good; the percentage change in quantity demanded divided by the percentage change in the price of the good.

Question 21

What is the definition of elastic demand?

Answer 21

Absolute value of own price elasticity is greater than 1

Question 22

What is the definition of inelastic demand?

Answer 22

Absolute value of the own price elasticity is less than 1

Question 23

What is the definition of unit elastic demand?

Answer 23

Absolute value of the own price elasticity is equal to 1

Question 24

What factors determine elasticity?

Answer 24

availability of substitutes, expenditure share, and time

Question 25

What is the relationship between revenue and demand elasticity?

Answer 25

Revenue is maximized when at unit elastic

Question 26

What is cross-price elasticity?

Answer 26

A measure of responsiveness of the demand for a good to changes in the price of a related good; the percentage change in the quantity demanded of one good divided by the percentage change in the price of a related good.

Question 27

What is income elasticity?

Answer 27

A measure of the responsiveness of the demand for a good to changes in consumer income; the percentage change in quantity demanded divided by the percentage change in income.

Question 28

How do you find the market rate of substitution?

Answer 28

slope of the budget line

Question 29

How do you find the marginal rate of substitution?

Answer 29

slope of the indifference curve

Question 30

PROBLEM: A lotto winner can choose between a single lump-sum payout of $105M this year or $200M in 25 years. Assume that the interest rate is 3%. Which is the better deal?

Answer 30

Lump Sum

Question 31

The manager of automated products is contemplating the purchase of a new machine that will generate revenue of $5000 for the next 5 years. Assume that the interest rate is 3%. What is the maximum price that he is willing to pay for the machine?

Answer 31

$22,898

Question 32

What is the value of a firm that generates profit of $30,000 every year? Assume that the interest rate is 3%.

Answer 32

$1M

Question 33

What is the equation for own price elasticity?

Answer 33

Eqxpx = alpha x (Px/Qx) OR (%changeQ/%changeP)

Question 34

What is the formula for cross price elasticity?

Answer 34

Eqxpy = alpha y (Py/Qx)

Question 35

What is the formula for income elasticity?

Answer 35

Eqxm = alpha m (M/Qx)

Question 36

What number defines an elastic good? inelastic?

Answer 36

Absolute value of >1 is elastic | Absolute value of <1 is inelastic

Question 37

If a company has an elastic good, what should it do to maximize revenue?

Answer 37

Decrease price

Question 38

If a company has an inelastic good, what happens to the firms revenue when it decreases prices?

Answer 38

With price decreases comes revenue decreases

Question 39

What is the indifference curve?

Answer 39

A curve that defines the combinations of two goods that give a consumer the same level of satisfaction.

Question 40

What is the marginal rate of substitution?

Answer 40

The rate at which a consumer is willing to substitute one good for another good and still maintain the same level of satisfaction; the slope of the indifference curve.

Question 41

What is the budget line?

Answer 41

The bundles of goods that exhaust a consumer's income.

Question 42

What is the market rate of substitution?

Answer 42

The rate at which one good may be traded for another in the market; the slope of the budget line. Mkt rate of sub = -Px/Py

Question 43

What is consumer equilibrium?

Answer 43

The equilibrium consumption bundle is the affordable bundle that yields the greatest satisfaction to the consumer. The tangent point between indifference curve and the budget line when MRS=Px/Py

Question 44

What is the formula for utility maximization condition?

Answer 44

MRS=Px/Py