Economics Exam 1-Roussel

Front 1

Deduction

Back 1

A method of reasoning in which one deduces a theory based on a set of almost self-evident principles

Front 2

Scarcity

Back 2

the goods available are too few to satisfy individual's desires

Front 3

Marginal cost

Back 3

the additional cost to ou over and above the costs you have already incurred

Front 4

sunk costs

Back 4

costs that have already been incurred and cannot be recovered

Front 5

marginal benefit

Back 5

the additional benefit above what you've already derived

Front 6

economic decision rule

Back 6

if the marginal benefits of doing something exceed the marginal costs, do it.

if the marginal costs of doing something exceed the marginal benefits, don't do it.

Front 7

Opportunity cost

Back 7

the benefit that you might have gained from choosing the next-best alternative

Front 8

market force

Back 8

an economic force that is given relatively free rein by society to work through the market

Front 9

invisible hand

Back 9

the price mechanism, the rise and fall of prices that guides our actions in a market

Front 10

abduction

Back 10

a method of analysis that uses a combination of inductive methods and deductive methodds

Front 11

economic model

Back 11

a framework that places the generalized insights of the theory in a more specific contextual setting

Front 12

economic principle

Back 12

a commonly held economic insight stated as a law or general assumption

Front 13

experimental economics

Back 13

a branch of economics that studies the economy through controlled laboratory experiments

Front 14

natural experiments

Back 14

naturally occurring events that approximate a controlled experiment where something has changed in one place but has not changed somewhere else

Front 15

efficiency

Back 15

achieving a goal as cheaply as possible

Front 16

invisible hand theorem

Back 16

a market economy, through the price mechanism, will tend to allocate resources efficiently

Front 17

microeconomics

Back 17

the study of individual choice, and how that choice is influenced by economic forces

Front 18

macroeconomics

Back 18

the study of the economy as a whole

Front 19

normative economics

Back 19

the study of what the goals of the economy should be

Front 20

art of economics

Back 20

the application of the knowledge learned in positive economics to the achievement of the goals one has determined in normative economics

Front 21

You rent a car for $29.95. The first 150 miles are free, but each mile thereafter costs 15 cents. You plan to drive it 200 miles. What is the marginal cost of driving the car?

Back 21

The marginal costs are the additional costs. They are 15 cents per mile for miles above 150 plus the cost of gas. Therefore the marginal cost is $7.50 plus the cost of gas. The initial payment can be forgotten because it is a sunk cost; it is not part of marginal costs.

Front 22

Economists estimated the government must spend $4,170 on druf control to deter one person from using drugs and the cost that one druf user imposes on society is $897. Based on this information alone, should the government spend the money on drug control?

Back 22

No, since the marginal cost of drug control exceeds the marginal benefit; government should not spend $4,170 to deter one person from using drugs.

Front 23

What is the opportunity cost of buying a $20000 car?

Back 23

The opportunity cost of buying a $20,000 car is the benefit we would have gained by using that $20,000 for the next-best alternative, which could be spending it on other goods and services, or saving it.

Front 24

Suppose you currently earn $30000 a year. You are considering a job that will increase your lifetime earnings by $300000 but that requires and MBA. The job will mean also attending business school for two years at an annual cost of $25000. You already have a bachelor's degree, for which you spent $80000 in tuition and books. Which of the above information is relevant to your decision whether to take the job?

Back 24

Only the marginal costs and benefits of taking the job are relevant. That means the sunk cost of the bachelor’s degree is irrelevant. Therefore, the relevant costs are the opportunity cost of taking the job (forgone earnings from your current job) and other things you could have done with the money you need to pay business school tuition. The relevant benefit is the increased lifetime earnings of $300,000.

Front 25

Suppose your college has been given $5 million. You have been asked to decide how to spend it to improve your college. Explain how you would use the economic decision rule and the concept of opportunity costs to decide how to spend it.

Back 25

I would spend the $5 million on those projects that provide the highest marginal benefit per dollar spent. The opportunity cost of spending the money on one project is the lost benefit that the college would have received by spending it on some other project. Thus, another way to restate the decision rule is to spend the money on the project that minimizes opportunity cost per dollar.

Front 26

Individuals have two kidneys, but most of us need only one. People who have lost both kidneys through accident or disease must be hooked up to a dialysis machine, which cleanses waste from their bodies. Say a person who has two good kidneys offers to sell one of them to someone whose kidney function has been totally destroyed. The seller asks $30000 for the kidney, and the person who has lost both kidneys accepts the offer. Who benefits from the deal? Who is hurt? Should a society allow such market transactions? Why?

Back 26

a. Both parties benefit. The person who gains the kidney benefits if it works when transplanted into his or her body, and will no longer have the emotional and financial burden of dialysis. The person selling the kidney gains the $30,000. Their gains will also have impacts on others (their families, for example).
b. Both parties must undergo surgery and face all of the attendant risks and costs. The seller also faces the potential cost of a future illness or injury harming his or her only remaining kidney causing a need for the seller to need dialysis.
c. Whether a society should allow this transaction is a question of value judgments and cultural norms. Our society has chosen not to allow such transactions because (among other reasons) those with more money would have increased access to organs and would therefore have advantages over those of limited means, and the poor could be exploited in such transactions.

Front 27

Macro or Micro: Should US interest rates be lowered to decrease the amount of unemployment?

Back 27

Macro

Front 28

Macro or Micro: Will the fact that more and more doctors are selling their practices to managed care networks increase the efficiency of medical providers?

Back 28

Micro

Front 29

Macro or Micro: Should the current federal income tax be lowered to reduce unemployment?

Back 29

Macro

Front 30

Macro or Micro: Should the federal minimum wage be raised?

Back 30

Micro

Front 31

Macro or Micro: Should Sprint and Verizon both be allowed to build local phone networks?

Back 31

Micro

Front 32

Macro or Micro: Should commercial banks be required to provide loans in all areas of the territory from which they accept deposits?

Back 32

Micro

Front 33

List two microeconomic and two macroeconomic problems

Back 33

Two microeconomic problems are the pricing policies of firms (price fixing in particular) and how wages are determined in labor markets. (Why do athletes and celebrities make so much money anyway?) Two macroeconomic problems are unemployment and inflation (business cycles and growth are also macroeconomic problems).

Front 34

Positive Economics, Normative Economics, or the Art of Economics: In a market, when quantity supplied exceeds quantity demanded, price tends to fall

Back 34

Positive statement since it is a statement of fact.

Front 35

Positive Economics, Normative Economics, or the Art of Economics: When determining tax rates, the government should take into account the income needs of individuals

Back 35

Normative

Front 36

Positive Economics, Normative Economics, or the Art of Economics: What society feels is fair is determined largely by cultural norms

Back 36

This could be seen as a positive statement since it is a statement of fact, although since it deals with normative issues, it could also be interpreted as a normative statement.

Front 37

Positive Economics, Normative Economics, or the Art of Economics: When deciding which rationing mechanism is best (lottery, price, first-come/first-served), one must take into account the goals of society

Back 37

Since this is relating a normative goal with a decision, this could be a statement in the art of economics. It could also be seen as a normative statement if one interprets it as a normative imperative.

Front 38

Positive Economics, Normative Economics, or the Art of Economics: California currently rations water to farmers at subsidized prices. Once California allows the trading of water rights, it will allow economic forces to be a market force

Back 38

Positive statement since it is a statement of fact.

Front 39

Show how a production possibility curve would shift if a society became more productive in its output of widgets but less productive in its output of wadgets.

Back 39

wadget production is measured on the vertical axis and widget production is measured on the horizontal axis. If the society becomes more productive in its output of widgets, it can produce more of them, and the end point of the curve on the horizontal axis will move to the right, as shown. If the society is also less productive in its production of wadgets, the end point on the vertical axis will move down, as shown. The result is a new production possibility curve.

Front 40

Show how a production possibility curve would shift if a society became more productive in the output of both widgets and wadgets.

Back 40

If a society became equally more productive in the production of both widgets and wadgets, the production possibility curve would shift out to the right .

Front 41

How does the theory of comparative advantage relate to production possibility curves?

Back 41

The theory of comparative advantage underlies the shape of the production possibility curve. By taking advantage of each person's comparative advantage, higher total output can be reached than if each produced all goods on his or her own, or if each produced goods for which he or she did not have a comparative advantage. As more and more of a good is produced, resources that have less of a comparative advantage are brought into the production of a good, causing the production possibility curve to be bowed outward.

Front 42

If neither of two countries has a comparative advantage in either of two goods, what are the gains from trade?

Back 42

There are no gains from trade when neither of two countries has a comparative advantage in either of two goods.

Front 43

Does the fact that the production possibilities model tells us that trade is good mean that in the real world free trade is necessarily the best policy? Explain.

Back 43

The fact that the production possibility model tells us that trade is good does not mean that in the real world, free trade is the best policy. The production possibility model does not take into account the importance of institutions and government in trade. For example, the model does not take into account externalities associated with some trades, the provision of public goods, or the need for a stable set of institutions or rules. The production possibility model shows maximum total output, but that is not the only societal goal to take into account when formulating policy.

Front 44

What effect has globalization had on the ability of firms to specialize? How has this affected the competitive process?

Back 44

Globalization increases competition by allowing greater specialization and division of labor. Because companies can move operations to countries with a comparative advantage, they can lower production costs and increase competitive pressures. The decreased importance of geographical location increases the size of potential markets, increasing the number of suppliers in each market and thus increasing competition.

Front 45

State the law of demand. Why is price inversely related to quantity demanded?

Back 45

The law of demand states that quantity demanded falls as price increases; or that quantity demanded rises as price falls. Price is inversely related to quantity demanded because as price rises, consumers substitute other goods whose price has not risen.

Front 46

List four shift factors of demand and explain how each affects demand.

Back 46

Four shift factors of demand are income, price of other goods, tastes, and expectations. A fifth shift factor is taxes and subsidies to consumers. As income rises, demand increases. As the prices of other substitute goods rise, demand increases. As tastes change to favor a particular good, the demand for that good increases. If people expect the price of a good to fall in the future, demand will fall now. Taxes reduce demand, while subsidies increase it.

Front 47

Distinguish the effect of a shift factor of demand on the demand curve from the effect of a change in price on the demand curve.

Back 47

A change in the price causes a movement along the demand curve to a new point on the same curve. A shift in the demand curve means that the quantities will be different at all prices; the entire curve shifts.

Front 48

State the law of supply. Why is the price directly related to quantity supplied?

Back 48

The law of supply states that quantity supplied rises as price increases or, alternatively, that quantity supplied falls as price decreases. Price is directly related to quantity supplied because, as price rises, people and firms rearrange their activities to supply more of that good in order to take advantage of the higher price.

Front 49

Mary has just stated that normally, as price rises, supply will increase. Her teacher grimaces. Why?

Back 49

Saying that supply increases means that the curve has shifted to the right, which is not the result of a price change. The correct statement is that, normally, as price rises, the quantity supplied increases, other things constant.

Front 50

List four shift factors of supply and explain how each affects supply.

Back 50

Shift factors of supply include the price of inputs, technological advances, changes in expectations, and taxes and subsidies. As the price of inputs increase, the supply curve shifts to the left. As technological advances are made that reduce the cost of production, the supply curve shifts to the right. If a supplier expects the price of her good to rise, she may decrease supply now to save and sell later. Other expectational effects are also possible. Taxes paid by suppliers shift the supply curve to the left. Subsidies given to producers shift the supply curve to the right.

Front 51

List four shift factors of supply and explain how each affects supply.

Back 51

Shift factors of supply include the price of inputs, technological advances, changes in expectations, and taxes and subsidies. As the price of inputs increase, the supply curve shifts to the left. As technological advances are made that reduce the cost of production, the supply curve shifts to the right. If a supplier expects the price of her good to rise, she may decrease supply now to save and sell later. Other expectational effects are also possible. Taxes paid by suppliers shift the supply curve to the left. Subsidies given to producers shift the supply curve to the right.

Front 52

Explain what a sudden popularity of "Economics Professor" brand casual wear would likely do to prices of that brand

Back 52

Customers will flock to stores demanding that funky “economics professor” look, creating excess demand (the demand curve shifts right). This excess demand will soon catch the attention of suppliers, and prices will be pushed upward.

Front 53

In a flood, usable water supplies ironically tend to decline because pumps and water lines are damaged. What will a flood likely do to prices of bottled water?

Back 53

As substitutes for bottled water—clean tap water—decrease, demand for bottled water increases enormously, and there will be upward pressure on prices. Social and political forces will, however, likely work in the opposite direction—against “profiteering” from people’s misery.

Front 54

The price of gas shot up significantly in 2008 to over $4.00 a gallon. What effect did this likely have on the demand for diesel cars that get better mileage that the typical car?

Back 54

Because the price of gas rose significantly, we’d expect people to purchase fewer gas-guzzlers and more fuel-efficient cars such as diesel cars (the demand for diesel cars will increase).

Front 55

Say that the equilibrium price and quantity both rose. What would you say was the most likely cause?

Back 55

If price and quantity both rise, the simplest cause would be a shift of the demand curve to the right.

Front 56

Say that the equilibrium price fell and quantity remained constant. What would you say was the most likely cause?

Back 56

If price fell and quantity remained constant, a possible cause would be a shift out to the right of the supply curve and a shift of the demand curve in to the left. Another possibility would be a shift of the demand curve in to the left with a vertical supply curve.

Front 57

The technology is now developing so that road use can be priced by computer. A computer in the surface of the road picks up a signal from your car and automatically charges you for the use of the road. How would this affect bottlenecks and rush-hours congestion?

Back 57

Computer pricing of roads could end bottlenecks and rush hour congestion by price rationing. Currently at zero price, at certain times, the quantity demanded greatly exceeds the quantity supplied, resulting in congestion. Raising prices, during those times, could eliminate excess demand and reduce the congestion. This technological change will spread out congestions over wider geographic areas and over the day, as individuals with more flexibility with respect to route and timing will choose to demand less of the current high demand route at rush hour.

Front 58

Determine the price elasticity of demand if, in response to an increase in price of 10 percent, quantity demanded decreases by 20 percent. Is demand elastic or inelastic?

Back 58

E = percentage change in quantity/percentage change in price=20/10=2. It is elastic.

Front 59

A firm has just increased its price by 5 percent over last year's price, and it found that quantity sold remained the same. The firm comes to you and wants to know its price elasticity of demand.

Back 59

Price elasticity of demand, if everything besides price and quantity is constant, is 0.

Front 60

A firm has just increased its price by 5 percent over last year's price, and it found that quantity sold remained the same. How would you calculate it?

Back 60

I would calculate it using E = percentage change in quantity/percentage change in price = 0/5 = 0.

Front 61

A firm has just increased its price by 5 percent over last year's price, and it found that quantity sold remained the same. What additional information would you search for before you did your calculation?

Back 61

c. I would check to see if other things did not remain constant.

Front 62

When tolls on the Dulles Airport Greenway were reduced from $1.75 to $1.00, traffic increased from 10,000 to 26,000 trips a day. Assuming all changes in quantity were due to the change in price, what is the price elasticity of demand for the Dulles Airport Greenway?

Back 62

The price elasticity of demand equals percentage change in quantity demanded divided by the percentage change in price = (16,000/18,000)/(.75/1.375)= 0.889/0.545 = 1.63.

Front 63

One football season Domino's Pizza, a corporate sponsor of the Washington Redskins, offered to reduce the price of its medium-size pizza by $1 for every touchdown scored by the Redskins during the previous week. Until that year, the Redskins weren't scoring many touchdowns. Much to the surprise of Domino's, in one week in 1999, the Redskins scored six touchdowns. Domino's pizzas were selling for $2 a pie! The quantity of pizzas demanded soared the following week from 1 pie an hour to 100 pies an hour. What was the price elasticity for Domino's pizza?

Back 63

Price elasticity of demand is equal to the percentage change in quantity divided by the percentage change in price. Pizzas went from $8 to $2 and quantity from 1 to 100. The price elasticity of demand is (99/50.5)/(6/5) = 1.63.

Front 64

A major cereal producer decides to lower price from $3.60 to $3 per 15-ounce box. If quantity demanded increases by 18 percent, what is the price elasticity of demand?

Back 64

Since the price falls by 60/330 (about 18%) the price elasticity would be approximately one.

Front 65

A major cereal producer decides to lower price from $3.60 to $3 per 15-ounce box. If, instead of lowering its price, teh cereal producer had increased the size of the box from 17 to 17.8 ounces, what would you expect that the response would have been? Why?

Back 65

Elasticity would be about the same (one), since price per ounce decreases by nearly 18% from $0.24 to $0.20.

Front 66

Federal Reserve Bank of Chicago economist William Hunter and G-7 Group economist Mary Rosenbaum estimated the demand elasticity for motor fuel to be between 0.4 and 0.85. If the price rises 10 percent and the initial quantity sold is 10 million gallons, what is the range of estimates of the new quantity demanded?

Back 66

A price rise of 10 percent will reduce fuel consumption anywhere from 4 to 8.5 percent. Quantity demanded would range from 9.23 to 9.61 million gallons.

Front 67

Federal Reserve Bank of Chicago economist William Hunter and G-7 Group economist Mary Rosenbaum estimated the demand elasticity for motor fuel to be between 0.4 and 0.85. In carrying out their estimates, they came up with different elasticity estimates for rises in price than for falls in price, with an increase in price having a larger elasticity that a decrease in price. What hypothesis might you propose for their findings?

Back 67

This suggests that there are other forces besides price at work here; making adjustments to higher prices is much easier than making adjustments to lower prices. This may be due to learning the true cost of substitutes when those substitutes are consumed. One can imagine a scenario in which a price hike significantly changes driving behavior—commuters may switch to ride sharing or public transportation, to which there may be perceived social barriers (costs). Once those barriers are overcome and the perceived costs are lowered after those alternatives are used, a larger decline in the price of gasoline is required to induce those who switched to return to driving their own cars.

Front 68

Which of the pairs of goods would you expect to have a greater price elasticity of demand?
a) Cars, transportation
b) Housing, leisure travel
c) Rubber during Worls War II, rubber during the entire 20th century

Back 68

a. Cars: The broader the category, the less elastic the demand.
b. Leisure travel: It is more of a luxury.
c. Rubber during the entire 20th century: There are more substitutes over a longer period of time.

Front 69

For the following good, state whether it is a normal good, a luxury, a necessity, or an inferior good. Explain your answer. Vodka

Back 69

Vodka: normal, luxury (except in Russia). Individuals tend to drink more hard liquor as their income rises. (It depends on the type: Absolut vodka is more of a luxury than store brands.)

Front 70

For the following good, state whether it is a normal good, a luxury, a necessity, or an inferior good. Explain your answer. Table salt

Back 70

Table salt: normal, necessity. It is a small portion of people’s income, and its consumption doesn’t increase much with income.

Front 71

For the following good, state whether it is a normal good, a luxury, a necessity, or an inferior good. Explain your answer. Furniture

Back 71

Furniture: Normal and luxury. Everyone needs some furniture, but as income goes up, people buy much more and much nicer furniture (elasticity is positive and greater than 1 in the short run).

Front 72

For the following good, state whether it is a normal good, a luxury, a necessity, or an inferior good. Explain your answer. Perfume

Back 72

Perfume: normal, luxury (depends on the type). The rich blow money on perfume; the rest of us get by with toilet water, or we smell a bit.

Front 73

For the following good, state whether it is a normal good, a luxury, a necessity, or an inferior good. Explain your answer. Beer

Back 73

Beer: normal. Income elasticity is positive but less than one.

Front 74

For the following good, state whether it is a normal good, a luxury, a necessity, or an inferior good. Explain your answer. Sugar

Back 74

Sugar: normal, necessity. It is not used significantly more by rich than by poor.

Front 75

Economists have estimated the following transportation elasticities. For each pair, explain possible reasons why the elasticities differ. a) Elasticity of demand for buses is 0.23 during peak hours and 0.42 during off-peak hours

Back 75

Peak hour travelers are likely to be commuters who have little choice but to go to work and therefore have lower demand elasticity than those who ride buses during off-peak hours, and are more likely using buses for errands or other more discretionary activities.

Front 76

Economists have estimated the following transportation elasticities. For each pair, explain possible reasons why the elasticities differ. b) Elasticity of demand for buses is 0.7 in the short tun and 1.5 in the long run

Back 76

Demand tends to be less elastic in the short run because there are fewer substitutes. If fares rose enough, in the long run people could find alternative modes of transportation – purchase a car, find someone to share rides with, etc.

Front 77

Economists have estimated the following transportation elasticities. For each pair, explain possible reasons why the elasticities differ. c) Elasticity of demand for toll roads is 4.7 for low-income commuters and 0.63 for high-income commuters

Back 77

Tolls are likely a much smaller portion of high income commuter’s total income, contributing to a less-elastic demand.

Front 78

Kean University Professor Henry Saffer and Wharton School of Business Professor Dave Dhaval estimated that if the alcohol industry increased the prices of alcoholic beverages by 100 percent underage drinking would fall by 28 percent and underage binge drinking would fall by 51 percent. a) What is the elasticity of demand of underage drinking and binge drinking? b) What might explain the difference in elasticities?

Back 78

a) The elasticity of demand for drinking is .28; the elasticity of binge drinking is .51.
b) Binge drinking is more elastic. One possible explanation is that binge drinking (drinking 5 or more drinks at one occasion) is a larger percent of one’s income and has a close substitute—drinking less. It is easier for students to decrease the amount they drink rather than to quit altogether.
Source: “Alcohol Advertising and Alcohol Consumption by Adolescents,” NBER Working Paper 9482.

Front 79

A newspaper recently lowered its price from 50 cents to 30 cents. As it did, the number of newspapers sold increased from 240,000 to 280,000.
a) what was the newspaper's elasticity of demand?
b) Given that elasticity, did it make sense for the newspaper to lower its price?
c) What would your answer be if much of the firm's revenue came from advertising and the higher the circulation, the more it could charge for advertising?

Back 79

a)0.31 (40,000/260,000)/(20/40).
b)Since the demand is inelastic, it doesn’t make sense to lower the price because it reduces the total revenue.
c)Then it makes sense to lower the price in order to increase the circulation for more advertising revenue.

Front 80

Once a book has been written, would an author facing an inelastic demand curve for the book prefer to raise or lower the book's price? Why?

Back 80

If the author is profit maximizing, he or she would prefer to raise the book’s price. Raising prices when the demand is inelastic increases revenue. Because the author’s cost is sunk cost, profit also rises.

Front 81

How is elasticity related to the revenue from a sales tax?

Back 81

If demand is inelastic, then raising tax rates will increase tax revenue paid by consumers. This principle works similarly with supply. With elastic supply and demand, increasing taxes will decrease quantity supplied and quantity demanded enough to cause a decrease in tax revenue. Thus, what happens to total tax revenue depends both on the elasticity of supply and demand.

Front 82

For the following pair of goods, state whether the cross-price elasticity is likely positive, negative, or zero. Explain your answers.
Lettuce, carrots.

Back 82

Close to zero. While they are substitutes, they are not close substitutes.

Front 83

For the following pair of goods, state whether the cross-price elasticity is likely positive, negative, or zero. Explain your answers.
Housing, furniture

Back 83

Negative. They are complements.

Front 84

For the following pair of goods, state whether the cross-price elasticity is likely positive, negative, or zero. Explain your answers.
Nike sneakers, Puma sneakers

Back 84

Positive. They are close substitutes.

Front 85

For the following pair of goods, state whether the cross-price elasticity is likely positive, negative, or zero. Explain your answers.
Jeans, formal suits

Back 85

Close to zero. They are at best distant substitutes.

Front 86

When the price of ketchup rises by 15 percent, the demand for hot dogs falls by 1 percent.
a) Calculate the cross-price elasticity of demand.
b) Are the goods complements or subsitutes?
c) In the original scenario, what would have to happen to the demand for hot dogs for us to conclude that hot dogs and ketchup are substitutes?

Back 86

a) Cross-price elasticity of demand= (percent change in demand)/(percent change in price of a related good)= -1/15= -0.07.
b) Hot dogs and ketchup are complements because the cross-price elasticity of demand is negative.
c) The demand for hot dogs would have to rise.