exam 2

Question 1

In your own words, briefly define what an externality is

Answer 1

When a third party bears a cost from a market

transaction in which they take no part

Question 2

Provide an example of a positive and a negative externality not presented in the lecture
notes from class.

Answer 2

positive: good smelling house
negative: bad smelling house

Question 3

External benefits:

Answer 3

When a third party benefits from a market

transaction in which they take no part

Question 4

What’s the difference between you eating a sandwich and

sitting in this lecture?

Answer 4

The sandwich is a rival good while the lecture is nonrival

Question 5

The Law of Demand:

Answer 5

As the price of a good increases, the quantity

demanded falls, ceteris paribus.

Question 6

Ceteris Paribus:

Answer 6

holding all else constant

Question 7

Demand Schedule

Answer 7

shows the relationship
between the price level and the quantity
demanded.

Question 8

The relative price:

Answer 8

the price of a good compared to the price of

other goods.

Question 9

Law of diminishing marginal utility:

Answer 9

As more units of a good are

consumed, additional units provide less utility.

Question 10

Consumer surplus:

Answer 10

The difference in the amount consumers are willing to pay and the price they actually pay (also known as the market equilibrium price)

Question 11

Quantity Supplied:

Answer 11

the amount of a good or service the firm plans

to sell in a given period at a given price.

Question 12

The Law of Supply

Answer 12

as the price for which a good can be sold
increases, the quantity of that good that is supplied will increase,
ceteris paribus.

Question 13

Factors affecting supply

Answer 13

• Price of good
• Costs of inputs
• Alternative uses of inputs
• Technology
• Regulation, Taxes

Question 14

Supply Schedule:

Answer 14

shows the relationship between

the price level and the quantity supplied.

Question 15

Opportunity Cost of Production:

Answer 15

the total economic
cost of producing a good or service.
• Includes the opportunity cost of all resources,
including those owned by the firm.
• The opportunity cost is equal to the value of the
production of other goods sacrificed as the result of
producing the good.

Question 16

What factors affect demand?

Answer 16

• Price of good
• Tastes
• Income
• Population
• Prices of other goods (substitutes & complements)

Question 17

Quantity demanded:

Answer 17

The amount of a good that
individuals want to consume given their income
and prices at a given point in time.

Question 18

Producer Surplus

Answer 18

The difference between the price suppliers actually receive (market
price) and the minimum price they would be willing to accept. It
measures the net gains to producers and resource suppliers from
market exchange. It is not the same as profit.

Question 19

The Role of Prices

Answer 19

1. Prices communicate information
to decisions makers.
2. Prices coordinate the actions of
market participants.
3. Prices motivate economic
players.

Question 20

Economic Efficiency

Answer 20

A situation in which all potential gains from trade have been realized.
Two conditions must be true:
All actions where marginal benefits> marginal cost occur.
All actions where marginal benefits< marginal cost do not occur.
In well-behaved markets, market equilibrium is efficient.
Recall: well-behaved markets ⇒ perfect competition, no externalities, property rights clearly defined, no information asymmetries and trust is present.

Question 21

Economic Efficiency Graphically:

Answer 21

A situation in which all of the potential gains from trade have been
realized. An action is efficient only if it creates more benefit than
cost. With well-defined property rights and competition, market
equilibrium is efficient.

Question 22

If P↑ and Q ↑

Answer 22

• Increase in Demand (shift out)
• Causes: ↑ income (normal good), ↑ population, ↑Psubstitute, ↓Pcomplement ,
↑Taste

Question 23

If ↓ P and ↓ Q

Answer 23

• Decrease in Demand (shift in)
• Causes: ↓ income (normal good), ↓ population, ↓Psubstitute, ↑Pcomplement ,
↓Taste

Question 24

If P↑ and Q ↓

Answer 24

• Decrease in Supply (shift in)

* Causes: ↑costs (wages, materials), ↓# of producers, ↑Palternative product

Question 25

If P ↓ and Q ↑

Answer 25

• Increase in Supply (shift out)
• Causes: ↓ costs (wages, materials), ↑ # of producers, ↓ Palternative product
,↑Technology

Question 26

Price Ceilings & Floors

Answer 26

• Price Floor: Minimum Wage

Question 27

Asymmetric Information

Answer 27

Occurs when information is held by one, but not all, of the parties involved in a transaction.
Examples:
1. Used Car Market.
2. Buying Professional Services.
3. Insurance Market.
4. Financial Markets.
5. Stock Market.
6. Food and Drug Markets.

Question 28

Why Information Asymmetries are a

concern.

Answer 28

1. Over-allocation of resources to production of harmful
   products.
   2.Adverse Selection
   3.Moral Hazard

Question 29

Rival good

Answer 29

• More consumption by one, means less consumption by others (a limited
# of consumers at a time)
• Examples?
• Food, clothing

Question 30

Nonrival Goods

Answer 30

• My consumption (or benefits) is not affected by you consuming more
(shared good)
• Examples?
• Air quality, lighthouse, national defense, information
(websites), parks, sporting events, movies

Question 31

What’s the difference between you spending time at a local

park and attending an UK basketball game?

Answer 31

The basketball game is excludible while the public park (by

design) is nonexcludible

Question 32

Excludible Good

Answer 32

• Possible to limit consumption and prevent individuals from consuming
(Can charge a price)
• Examples?
• Food, clothing, sporting events, movies