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Unit II – Definition and Application Questions Mr. Stewart’s AP Microeconomics Class Fall Semester 2016 *For AP Review Concept/Topic/Term: Define Each Topic: Microeconomics and the Circular Flow Model Microeconomics: The interactions between individuals and businesses Application Questions: Circular Flow: Individuals and Businesses interact in two distinct markets: Product Markets – we are the consumers (buyers) and businesses are the producers (sellers) Factor/Resource Markets – we are the producers (sellers) and businesses are the consumers (buyers) Demand: Demand Quantity Demanded Law of Demand Demand Curve Determinants of Demand Demand – the desire and ability to consume Which of the following situations best illustrates the law of demand? Quantity Demanded – specific quantity demanded at a specific price (moves ALONG the demand curve, and only changes in response to price) A.) As real incomes of United States citizens have decreased over the past year, the demand for housing has also decreased. B.) Recent decreases in the price of imported wine have led to an increase in the consumption of domestic wine. C.) In the past several months, as the price of compact disc players has decreased, the quantity of compact disc players sold had increased. D.) The increase in the price of quality health foods has increased the revenues of firms producing these goods. E.) As the demand for computers has increased, the number of workers in the computer industry has increased. Law of Demand – Ceteris paribus, if PRICE INCREASES, then QUANTITY DEMANDED DECREASES (and vice versa) *Price and Quantity have an INVERSE RELATIONSHIP Demand Curve – Demonstrates the inverse relationship between price and quantity demanded (law of demand), slopes DOWN AND TO THE RIGHT, due to the INCOME AND SUBSTITUTION EFFECTS!!!! (As price increases people look for cheaper alternatives, and as price increases people can’t afford as much) Non-Price Determinants of Demand – SHIFT THE ENTIRE DEMAND CURVE. This SHIFT represents either an INCREASE (outward/rightward) shift or a DECREASE (inward/leftward) shift in DEMAND. An Increase in Demand corresponds to higher prices and higher quantity, and a DECREASE in DEMAND corresponds to lower prices and lower quantity. (PRICE DOES NOT AFFECT DEMAND OR SHIFT THE CURVE, IT ONLY EFFECTS QUANTITY DEMANDED ALONG THE CURVE) Income Taste and Preferences Substitute Goods Complimentary Goods # of Buyers Consumer Information Available Future Price Expectations The demand curve for a normal good slopes down for which of the following reasons? I. An increase in the price of the good induces consumers to purchase substitute products. II. An increase in the price of the good reduces consumer’s purchasing power. III. An increase in the price of the good increases consumers’ utility from consuming that good. a. b. c. d. I only II only III only I and II only e. I and III only Concept/Topic/Term: Definition Questions: Application Questions: The American Heart Association has just issued a report warning consumers about the negative health effects of eating beef. Which of the following changes in the beef market is most likely to occur as a result? A.) The supply curve will shift to the left, increasing the price of beef. B.) The demand curve will shift to the left, decreasing the price of beef. C.) The demand curve will shift to the right, increasing the price of beef. D.) Neither the supply nor the demand curve will shift; only quantity will increase as price decreases. E.) Neither the supply nor the demand curve will shift; only quantity will decrease as price increases. Which of the following events will cause the demand curve for hamburgers to shift to the right? a. b. c. d. e. An increase in the price of pizza, a substitute for hamburgers. An increase in the price of French fries, a compliment to hamburgers. An increase in the price of hamburgers. A decrease in the price of hamburgers. A decrease in the cost of producing hamburgers. Which of the following will decrease the demand for beef? A.) An increase in the price of pork, if pork and beef are substitute goods B.) An increase in the price of potatoes, if potatoes and beef are complimentary goods C.) A decrease in the cost of transporting beef to consumers D.) An increase in the income levels of most consumers, if beef is a normal good E.) Research showing beef is better for your health than chicken Compliments and Substitutes Compliments and Substitutes – These are one of the non-price determinants of demand, meaning they will SHIFT the ENTIRE DEMAND CURVE. Compliments are things that go together and the INCREASE (decrease) in the PRICE OF ONE, will results in a DECREASE (increase) in the entire DEMAND FOR THE OTHER!!! If an increase in the price of good X causes a drop in demand for good Y, good Y is A.) B.) C.) D.) E.) An inferior good A luxury good A necessary good A substitute good for X A compliment to good X Assume that popcorn and movie attendance are compliments and that Salty Concession grows corn suitable for popping. Mr. Concession will most likely sell a greater quantity of popping corn at a higher price if which of the following occurs? A.) The wages of farm workers and movie theater employees increase. B.) A technological improvement results in less expensive and more efficient harvesting of corn. C.) The introduction of new fat-free potato chips provides new competition in the snack-food market. D.) The release of three summer movies sets records for movie attendance. E.) New government regulations force movie theaters to hire more guards at each theater. Concept/Topic/Term: Definition Questions: If the demand for good Y increases as the price of good X decreases, it can be concluded that: a. X and Y are substitute goods b. X and Y are complimentary goods c. X is an inferior good and Y is a superior good d. X is a superior good and Y is an inferior good e. Both X and Y are inferior goods If the increase in the price of one good decreases demand for another, then the two goods are A.) B.) C.) D.) E.) Income and Substitution Effects Inferior goods Luxury goods Normal goods Substitute goods Complementary goods Income and Substitution Effects – As the price of a good rises, people have to spend a larger portion of their incomes on that good (assuming their incomes stay the same), people will then look for substitutes, or cheaper alternatives. This is the reason the demand curve slopes DOWNWARD. Application Questions: The demand curve for cars is downward sloping because an increase in the price of cars leads to A.) The increased use of other modes of transportation. B.) A fall in the expected future price of cars. C.) A decrease in the number of cars available for purchase. D.) A rise in the prices of gasoline and other oil based products. E.) A change in consumers’ tastes in cars. Which of the following is true of the substitution effect of an increase in the price of a normal good? A.) B.) C.) D.) E.) It works to offset the income effect It works to reinforce the income effect It is less than the income effect It causes an increase in the quantity demanded for the good It causes an increase in the demand for the good The demand curve for a normal good slopes down for which of the following reasons? I. An increase in the price of the good induces consumers to purchase substitute products. II. An increase in the price of the good reduces consumer’s purchasing power. III. An increase in the price of the good increases consumers’ utility from consuming that good. a. I only b. II only c. III only d. I and II only e. I and III only Types of Goods Normal Goods Inferior Goods Luxury Goods The types of goods refer to how consumers change their habits when their INCOMES CHANGE: Normal Goods = Income INCREASES, purchases also INCREASE (I make more, I buy MORE) Inferior Goods = Income INCREASES, purchases DECREASE (I make more, I buy LESS) Luxury Goods = Income INCREASES, I spend a higher percentage of my income on that thing If the demand for potatoes increases whenever a person’s income increases, then potatoes are an example of A.) B.) C.) D.) E.) An inferior good A free good A Giffen good A normal good A public good Suppose that a family buys all its clothing from a discount store and treats these items as inferior goods. Under such circumstances, this family’s consumption of discount store clothing will necessarily A.) Increase when a family member wins the state lottery. B.) Increase when a family member gets a raise in pay at work. C.) Remain unchanged when its income rises or falls due to events beyond the family’s control. D.) Decrease when a family member becomes unemployed. E.) Decrease when a family member experiences an increase in income. Concept/Topic/Term: Definition Questions: Application Questions: If bologna is an inferior good, which of the following must be true? A.) The demand curve for bologna is vertical. B.) The demand curve for bologna is horizontal. C.) An increase in the price of bologna will decrease the supply of bologna. D.) An increase in consumer income will decrease demand for bologna. E.) A decrease in consumer income will decrease the supply of bologna. Supply: Supply Quantity Supplied Law of Supply The Supply Curve Determinants of Supply Supply – the desire and ability to produce (sell) If the government imposes a tax on the production of cars, which of the following will occur in the market for cars? Quantity Supplied – specific quantity supplied at a specific price (moves ALONG the supply curve, and only changes in response to price) Law of Supply – Ceteris paribus, if PRICE INCREASES, then QUANTITYT SUPPLIED INCREASES (and vice versa) *Price and Quantity have an DIRECT RELATIONSHIP A.) There will be a movement to the right along the supply curve. B.) There will be a movement to the right along the demand. C.) The supply curve will shift to the right. D.) The supply curve will shift to the left. E.) The demand curve will shift to the right. The supply curve for automobiles will shift left in response to Supply Curve – Demonstrates the direct relationship between price and quantity supplied (law of supply), slopes UP AND TO THE RIGHT!!!! a. b. c. Non-Price Determinants of Supply – SHIFT THE ENTIRE Supply CURVE. This SHIFT represents either an INCREASE (outward/rightward) shift or a DECREASE (inward/leftward) shift in SUPPLY. An INCREASE in SUPPLY corresponds to higher quantity and lower prices, and a DECREASE in SUPPLY corresponds to lower quantity and higher prices. (PRICE DOES NOT AFFECT SUPPLY OR SHIFT THE CURVE, IT ONLY EFFECTS QUANTITY SUPPLIED ALONG THE CURVE) Production Costs Changes in technology Taxes and Subsidies # of Sellers Future Price Expectations Time Needed for Production Costs of goods using the same resource d. e. An increase in the efficiency of robot technology. An increase in wages in the automobile industry. A decrease in the number of consumers purchasing automobiles. A decrease in interest rates for automobile loans. A decrease in consumers’ incomes. A leftward shift in the supply of corn would result from A.) B.) C.) D.) E.) A decrease in the price of corn. A decrease in the price of farm machinery. An increase in the demand for corn bread. An increase in the labor costs of producing corn. An increase in the consumers’ incomes. An improvement in production technology for a certain good leads to A.) B.) C.) D.) E.) An increase in the demand for the good. An increase in the supply of the good. An increase in the price of the good. A shortage of the good. A surplus of the good A leftward shift in the supply curve of watches could be caused by: A.) An increase in the price of watches B.) An increase in wages paid to workers who produce watches C.) An improvement in the technology associated with watchmaking D.) A decrease in the price of parts used in the production of watches E.) An increase in population If growing corn becomes more profitable than growing wheat, which of the following will occur? A.) B.) C.) D.) E.) The supply of corn will decrease The price of wheat will decrease The price of corn will decrease The demand for wheat will increase The demand for corn will increase Concept/Topic/Term: Market Equilibrium Buyers and Non-Buyers, Sellers and Non-Sellers Surplus and Shortages Definition Questions: Application Questions: Market Equilibrium – Is the point at which the supply curve and demand curve meet and intersect, it represents the perfect price and quantity at which both buyers and sellers are SATISFIED, and also where QD=QS Market Equilibrium splits the demand curve and the supply curve in half, where those ABOVE equilibrium on the demand curve are BUYERS (they all receive some benefit/consumer surplus) and all those below are NON-BUYERS (the price was too high, or they found substitutes), and where those BELOW equilibrium on the supply curve are the SELLERS (they receive some benefit/producer surplus from selling), and all of those above equilibrium are NON-SELLERS (their costs of production are too high at the equilibrium price to make any profit Which of the following would cause the equilibrium price of good X to increase? A.) Producers of good X find a new technology that reduces the cost of producing good X B.) The price of an essential input in the production of good X increases C.) Goods X and Y are compliments, and the government imposes a tax on good Y D.) Good X is a normal good, and the government increases income taxes by 3% E.) Good X is an inferior good, and the government decreases income taxes by 10% Anytime price is ABOVE equilibrium, this will cause a SURPLUS (too much supply and not enough demand) and market forces will push the price down, and anytime price is BELOW equilibrium, this will cause a SHORTAGE (too much demand and not enough supply) and market forces will push price up Supply and Demand Together ***See your Unit II Rules to Remember*** Numbers 3 and 4 Consumer and Producer Surplus Consumer Surplus – Is the benefit (utility) received from everyone who bought (all the BUYERS), it is everyone who paid less (market price) than they would have been WILLING to pay (basically everyone who WOULD have paid more, they all think they got a great deal) Producer Surplus – is the benefit (profit) received by the producers (basically anyone who SOLD), it is all of the PRODUCERS who would have been WILLING to SELL at a LOWER price, but got the benefit of selling at the market (equilibrium) price Consumer surplus is defined as: A.) Opportunity cost minus total revenue B.) Total revenue minus opportunity cost C.) The difference between the resource costs and the price the consumers pay D.) The difference between the value that the consumers place on a good and the price they pay E.) The sum of the external costs and benefits The difference between the price a consumer would be willing to pay for a cone of ice cream and the actual market price that she pays giver a measure of her: A.) Consumer surplus B.) Producer surplus C.) Marginal utility D.) Marginal cost E.) Ability to pay Which of the following best illustrates the concept of consumer surplus? A.) A thirsty athlete pays $0.85 for a cold drink when she would gladly paid $1.50 for the drink. B.) An individual who is willing to accept a job at $7.50 per hour is offered $7.00 per hour. C.) An individual pays the sale price of $15.00 for the same shirt that the individual refused to purchase earlier at $18.00. D.) An individual finds that the price of artichokes, a food she dislikes, has been reduced by 50 percent. E.) A wood-carver has a marginal cost of $5.00 for a unit of output, but sells that unit at $6.00. Concept/Topic/Term: Total/Economic Surplus or Gains from Trade Definition Questions: Application Questions: Total/Economic Surplus or Gains from Trade – Refers to the total benefit received from adding together BOTH consumer surplus and producer surplus. It is assumed that markets are both allocatively and productively efficient, and therefore all total surplus and gains from trade are received by society (both the buyers and the sellers). In the case of imperfect competition (like monopolies), or market interference (like government price controls) then some of the total surplus is lost (which is what we call DEADWEIGHT LOSS = loss to society) When the market is in equilibrium, the total economic surplus is equal to area A. B. C. D. E. Elasticity of Demand: Elastic Inelastic Unit (Unitary) Elastic Cross-Price Elasticity Elasticity (of demand) – How does your behavior change in response to a change in price: Elastic – Behavior does/will change Inelastic – Behavior does not/cannot change *Things that affect elasticity are whether or not the item is essential/non-essential, how many substitutes there are (more substitutes the more elastic), and how much time I have to make a decision (shorter time frame the more inelastic, the more time, the more time I have to change my behavior, or the more elastic) *Elasticity is calculated by taking the change in quantity divided by the change in price. The closer the number is to ZERO the more INELASTIC (with zero being perfectly inelastic), if the number is GREATER THAN 1, than it is ELASTIC (doesn’t matter if it’s positive or negative), and if it is EXACTLY 1, then it is considered UNIT (Unitary) elastic. *Elasticity also effects the SLOPE of the supply and demand curves. For both curves, the more ELASTIC the more HORIZONTAL the curve (a small price change has a large quantity change), and the more INELASTIC, the more VERTICAL the slope of the curve (even a large price change results in only a small quantity change) *Cross-Price elasticity is simply how the elasticity of one good affects the elasticity of another (substitutes and compliments) f+k f+g+i+k g+h+i+j f+g+h+i+j+k f+g+h+i+j+k+l+m To alleviate a financial crisis, a university increases student fees. This action will increase university revenues if the price elasticity of demand for university education is: a. b. c. d. e. Inelastic Unit elastic Elastic Equal to the price elasticity of supply Equal to one The price of an airline ticket is typically lower if a traveler buys the ticket several weeks before the flight’s departure date rather than on the day of the departure. This pricing strategy is based on the assumption that: A.) Travelers are not aware of how airline prices change across time B.) Travelers do not have alternative modes of transportation C.) Travelers will pay any price to travel as the departure date approaches D.) The marginal cost of the last few seats on an airplane is higher than that for the first few seats E.) Traveler’s demand comes less elastic as the departure date approaches Assume that demand for bottled water is relatively price elastic. An increase in supply of bottled water will result in which of the following? A.) A decrease in price, leading to an increase in total revenue B.) A decrease in price, leading to a decrease in total revenue C.) An excess supply of bottled water D.) An excess demand of bottled water E.) A relatively small decrease in price and no change in equilibrium quantity Concept/Topic/Term: Definition Questions: Application Questions: Assume that the price of good X decreases form $10 to $9 per unit and that the quantity demanded of good X increases from 25 to 30 units. In this price range, the demand for good X is: A.) B.) C.) D.) E.) Elasticity of Supply Elasticity of supply: How producers react to changes in price Elastic = producers can/will change their production Inelastic = producers can’t/won’t change their production ***All producers would like to be more elastic, however, changing production in the shortrun is limited to changing labor Short-Run versus Long-Run (time perspective) Fixed versus variable costs Businesses/Producers would love to be more elastic (be able to CHANGE THEIR PRODUCTION), but because in the short-run at least ONE factor is FIXED (like the size of my store/restaurant), producers are usually somewhat inelastic (can’t change), and the only thing they CAN CHANGE in the short-run is LABOR. Inelastic Elastic Unit elastic Perfectly inelastic Perfectly elastic Which of the following must be true if the revenues of wheat farmers increase when the price of wheat increases? a. b. c. d. The supply of wheat is price elastic. The supply of wheat is income elastic. The supply of wheat is income inelastic. The demand for wheat is price elastic. e. The demand for wheat is price inelastic. If a store raises its prices by 20 percent and its total revenue increases by 10 percent, the demand it faces in this price range must be A.) Inelastic B.) Elastic C.) Unit elastic D.) Perfectly elastic E.)Perfectly Inelastic Assume that the price elasticity of demand for good X is constant and equal to 0.5 and the price elasticity of demand for good Y is constant and equal to -2. Assume that goods X and Y have identical upward-sloping elastic supply curves. If a per-unit excise tax of the same amount is levied on good X and on good Y, which of the following would be true? A.) The percentage decrease in the quantity of good X demanded would be greater than the percentage decrease in the quantity of good Y demanded B.) The tax share paid by consumers of good X would be relatively higher than that paid by consumers of good Y C.) The tax share paid by consumers of good Y would be relatively higher than that paid by consumers of good X D.) The tax share paid by sellers of good Y would be relatively lower than that paid by the sellers of good X E.) The tax share paid by sellers of goods X and Y would be the same