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First Midterm Review
HON 220
Professor Mark Pingle
Home phone 358-8546 Office phone 784-6634
Spring 2003
Foundations of economics: S1, Buc Intro, Buc Conclusion, Buc Appendix, S22, S25
Concepts: Opportunity cost
Be able to:
 Relate resource scarcity to choice and to the concept of cost
 Identify unintended consequences of a new policy by thinking about how the new policy
changes incentives (often by changing constraints).
 Explain why it may not be reasonable to distinguish a need from a want
 Explain why most of the time people say others “waste” resources, the use of the word
waste may be misleading.
Vocabulary: Satisfaction, utility, satiation, scarcity, choice, cost, alternatives, constraint,
tradeoff, efficient, inefficient, diminishing marginal utility.
Technical tools:
 Identify a functional form that makes sense for use as a utility function.
 In a diagram and using calculus, distinguish diminishing marginal utility.
Markets: Role of prices: S2, S3, Buc3, S23
Concepts: Price mechanism, invisible hand
Be able to:
 Explain how price changes send signals
 Explain how price changes coordinate the trading desires of buyers and sellers
 Explain how markets (or prices) ration a good, and discuss how this rationing process
might differ from how government would ration the good.
 Use a market model to explain why a market price changes.
 Use a market model to explain why a quantity bought and sold in the market changes.
 Government might determine what is produced, for whom, and how much. Explain how
markets will do this job (and therefore allow for more limited government).
 Relative to the role markets can play, explain why it is important to consider not only the
form of government (e.g., democracy versus dictatorship), but also whether or not
government should get involved in allocating a particular resources.
 Explain how markets channel greed or self interest into socially useful activities.
 Explain why greed channeled through government is likely to have more negative
consequences than greed channeled through markets.
 Explain how prices affect profits, and in turn how profitability is a signal to producers
about what to produce and what not to produce.
 Explain how prices reduce information costs by reducing the “need to know.”
 Explain why physical scarcity will not necessarily mean there is a shortage of a good if
the market for the good is allowed to work.
 Explain why individual business owners do not actually have much control over the prices
they charge for their products.
 Explain why government will tend to provide less variety when it provides a good than a
market would provide.
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Vocabulary: Competition, product prices, factor (input) prices, profit, revenue, cost
Technical tools:
 Show diagrammatically how a price adjustment can eliminate a surplus or shortage (a
movement along a curve).
 Show diagrammatically, how a shock to a market can create a surplus or shortage (a shift
in a supply or demand curve).
 Plot and analyze linear supply and demand curves.
Market Applications: S4, Buc4, Bar4 to page 164.
Concepts: Price mechanism, invisible hand, price controls, public choice, consumer surplus,
producer surplus, relative price, public good, externality, marginal benefit, marginal cost, social
cost, internalizing an externality, private property, tax amnesty, time inconsistency.
Be able to:
 Explain how and why price controls (i.e. price ceilings or price floors) tend to create
surpluses or shortages.
 Explain why proposals to control prices are popular among politicians.
 Identify the unintended consequences associated with rent control and farm price support
programs.
 Identify who is helped and who is hurt by a particular price control.
 Show that any particular price control will hurt some more than it helps others, meaning
those who are hurt should be willing to compensate those how are helped in order to avoid
the price control.
 Explain why developing a brand name is not just a marketing ploy but actually may have
real economic value.
 Explain why sellers seek to differentiate their products, and be able to use this to explain
why advertising has economic value.
 Be able to explain why a public good often is subject to the “tragedy of the commons.”
 Show why a Pigouvian tax can internalize a negative externality using both words and a
diagram
 Explain how and why creating a market for permits to pollute can effectively address a
pollution problem.
 Explain why prohibiting an activity that can cause damage to others (like smoking) is not
only not necessary to adequately protect those being injured, but also may be counter
productive.
 Explain why taking a market like the market for health care and socializing the payments
made (or costs incurred) by buyers, either through insurance or though government
payments, can lead to a tragedy of the commons problem.
 Explain why paying for items though insurance creates a moral hazard problem.
 Explain why medical care savings accounts and large deductibles might each help
improve the allocation of health care resources.
 Explain why government’s role of an information provider (e.g. government provides
information that wearing a seat belt reduces the probability of dying in an auto accident) is
fundamentally different than government’s role as a regulator (e.g., government passes a
law that requires you to were your seat belt).
 Explain why some policy ideas that at first seem appealing may ultimately not be good
ideas because they exhibit time inconsistency.
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
Discuss how things might change if we moved from a school system where the education
is provided directly by government to a system where education is privately provided but
paid for through publicly funded vouchers.
 Discuss how an endangered species (like say elephants in Africa) might be protected using
a market solution rather than through government regulation.
Vocabulary: price ceiling, price floor, welfare triangle, branding, product differentiation,
expenditure of buyer, revenue of seller, (Pareto) inefficiency, tragedy of the commons, externality,
marginal benefit, marginal cost, social cost, private property, moral hazard, tax amnesty, time
inconsistency.
Technical tools:
 Use the concepts consumer surplus and producer surplus in a market diagram to example
how the change in a price ceiling or price floor will affect the welfare of consumers and
producers.
 Construct relative prices from money prices, so that the relative price shows the relative
value of two goods in the market places.
Elasticity: Handout
Concepts: Elasticity, elasticity of demand with respect to price, elasticity of supply with respect
to price,
Be able to:
 Explain when the elasticity of demand with respect to price will tend to be more elastic
and when it will tend to be more inelastic
 Explain why revenue is maximized when the elasticity of demand with respect to price is
unitary elastic.
 Show how a change in the elasticities of the supply and demand curves in a market will
impact how the price in the market will change in response to a shock.
Vocabulary: elastic, inelastic, unitary elastic, point elasticity
Technical tools:
 Differential of a natural log is a growth rate
 Calculating an elasticity by using the natural log and differential to take a model that is in
the “levels” and turn it into a model that contains an elasticity.
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