REVIEW Flashcards
What is the difference between microeconomics and
macroeconomics?
Microeconomics studies the economic behavior of individual economic decision makers, such as a consumer, a worker, a firm, or a manager. Macroeconomics studies how an entire national economy performs, examining such topics as the aggregate levels of income and employment, the levels of interest rates and prices, the rate of inflation, and
the nature of business cycles.
Why is economics often described as the science of
constrained choice?
While our wants for goods and services are unlimited, the resources necessary to produce those goods and services, such as labor, managerial talent, capital, and raw materials, are “scarce” because their supply is limited.
This scarcity implies that we are constrained in the choices we can make about which goods and services to produce.
Thus, economics is often described as the science of constrained choice.
How does the tool of constrained optimization help
decision makers make choices? What roles do the objective function and constraints play in a model of constrained optimization?
Constrained optimization allows the decision maker to select the best (optimal) alternative while accounting for any possible limitations or restrictions on the choices.
The objective function represents the relationship to be maximized or minimized. For example, a firm’s profit might be the objective function and all choices will be evaluated in the profit function to determine which yields the highest profit.
The constraints place limitations on the choice the decision maker can select and defines the set of alternatives from which the best will be chosen.
Suppose the market for wheat is competitive, with
an upward-sloping supply curve, a downward-sloping
demand curve, and an equilibrium price of $4.00 per bushel. Why would a higher price (e.g., $5.00 per bushel) not be an equilibrium price? Why would a lower price (e.g., $2.50 per bushel) not be an equilibrium price?
If the price in the market was above the equilibrium price, consumers would be willing to purchase fewer units than suppliers would be willing to sell, creating an excess supply.
As suppliers realize they are not selling the units they have made available, sellers will bid down the price to entice more consumers to purchase their goods or services. By definition, equilibrium is a state that will remain unchanged as long as exogenous factors
remain unchanged. Since in this case suppliers will lower their price, this high price cannot be an equilibrium.
When the price is below the equilibrium price, consumers will demand more units than suppliers have made available. This excess demand will entice consumers to bid up the prices to purchase the limited units available. Since the price will change, it cannot be an equilibrium.
What is the difference between an exogenous variable and an endogenous variable in an economic model? Would it ever be useful to construct a model that contained only exogenous variables (and no endogenous variables)?
Exogenous variables are taken as given in an economic model, i.e., they are determined by some process outside the model, while endogenous variables are determined within the economic model being studied.
An economic model that contained no endogenous variables would not be very interesting. With no endogenous variables, nothing would be determined by the model so it would not serve much purpose.
Why do economists do comparative statics analysis?
What role do endogenous variables and exogenous variables play in comparative statics analysis?
Comparative statics analyses are performed to determine how the levels of endogenous variables change as some exogenous variable is changed. This type of analysis is very important since in the real world the exogenous variables, such as weather, policy tools,
etc. are always changing and it is useful to know how changes in these variables affect the levels of other, endogenous, variables.
An example of comparative statics analysis would be asking the question: If extraordinarily low rainfall (an exogenous variable) causes a 30 percent reduction in corn supply, by how much will the market price for corn
(an endogenous variable) increase?
What is the difference between positive and normative analysis? Which of the following questions would entail positive analysis, and which normative analysis?
a) What effect will Internet auction companies have on
the profits of local automobile dealerships?
b) Should the government impose special taxes on sales
of merchandise made over the Internet?
Positive analysis attempts to explain how an economic system works or to predict how it will change over time by asking explanatory or predictive questions. Normative analysis focuses on what should be done by asking prescriptive questions.
a) Because this question asks whether dealership profits will go up or down (and by
how much) – but refrains from inquiring as to whether this would be a good thing
– it is an example of positive analysis.
b) On the other hand, this question asks whether it is desirable to impose taxes on
Internet sales, so it is normative analysis. Notably, this question does not ask
what the effect of such taxes would be.
Explain why a situation of excess demand will result in an increase in the market price. Why will a situation of
excess supply result in a decrease in the market price?
Excess demand occurs when price falls below the equilibrium price. In this situation, consumers are demanding a higher quantity than is being made available by suppliers. This creates pressure for the price to increase. As the price increases, quantity demanded will fall as quantity supplied increases returning the market to equilibrium.
Excess supply occurs when price is above the equilibrium price. Suppliers have made available more units than consumers are willing to purchase at the high price. This creates pressure for the price to decrease. As the price decreases, the quantity demanded will go up while at the same time the quantity supplied will decrease, returning the market to equilibrium.
Use supply and demand curves to illustrate the impact of the following events on the market for coffee:
a) The price of tea goes up by 100 percent.
b) A study is released that links consumption of caffeine
to the incidence of cancer.
c) A frost kills half of the Colombian coffee bean crop.
d) The price of styrofoam coffee cups goes up by 300
percent.
An increase in the price of a substitute, such as tea, will increase demand for coffee, raising the market equilibrium price and quantity.
a. This study will reduce demand for caffeine drinks, lowering the market equilibrium price and quantity.
b. The frost will reduce supply raising the equilibrium price while lowering the equilibrium quantity.
c. Increasing the price of an input for a cup of coffee will reduce supply, increasing market price and reducing market quantity. This will result in the same figure as
that for part c).
Suppose we observe that the price of soybeans goes
up, while the quantity of soybeans sold goes up as well.
Use supply and demand curves to illustrate two possible
explanations for this pattern of price and quantity changes.
Any factor increasing demand and leaving the remainder of the market unchanged will increase both market price and quantity sold. If demand were to increase at the same time as supply changed, both market price and quantity sold could increase if the change in demand is large relative to the change in supply.
A 10 percent increase in the price of automobiles reduces the quantity of automobiles demanded by 8 percent. What is the price elasticity of demand for automobiles?
-0.80
A linear demand curve has the equation Q= 50 - 100P. What is the choke price?
0.5
Explain why we might expect the price elasticity of
demand for speedboats to be more negative than the
price elasticity of demand for light bulbs.
Speedboats could probably be categorized as a luxury item whereas light bulbs are more likely categorized as a necessity. For the necessity, the change in quantity demanded will be relatively small for any percent change in price. The change in quantity demanded
may be quite large, however, for a luxury item. Since the percent change in quantity demanded is likely higher for the luxury item for any given percent change in price, the elasticity of demand would be less (more negative).
Many business travelers receive reimbursement
from their companies when they travel by air, whereas
vacation travelers typically pay for their trips out of their
own pockets. How would this affect the comparison between the price elasticity of demand for air travel for
business travelers versus vacation travelers?
Because business travelers receive reimbursement for expenses, they will probably be less sensitive to price changes than the vacation traveler who pays out of her own pocket. This implies the price elasticity for vacationers would be less (more negative) than for
business travelers.
Explain why the price elasticity of demand for an entire product category (such as yogurt) is likely to be less negative than the price elasticity of demand for a typical
brand (such as Dannon) within that product category.
If the prices for a particular product, such as Dannon, within a product category changes (say it increases) then it is easy for a consumer to switch to another brand, implying a relatively high percent change in quantity demanded for the product. On the other hand,
if prices for the entire product category change, substitutes are not as easily found and the percent change in quantity demanded for the category will be relatively lower. This implies the elasticity for the entire product category will be higher (less negative) than the
elasticity for a single product.
