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Midterm II Study Guide

Midterm II Study Guide - Econ Study Guide Midterm II 7...

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Econ Study Guide: Midterm II 7. Utility and Demand Utility is the benefit or satisfaction a person gets from the consumption of a good or service. o Total utility : total benefit o Marginal utility : the change in utility from a one-unit increase in the good/service Positive, BUT due to LDMU , falls as consumption increases. Consumer Equilibrium maximizes utility o Occurs when consumer income is allocated in a way that maximizes total utility All income is spent & MU per dollar spent is equal for all goods o Marginal Analysis : if the marginal gain from an action exceeds the marginal loss, take the action. Predictions of MU o Fall in price of an item raises MU Q d increases o Results in decrease in Q d for substitute item o Vice versa also true o With a larger income, the consumer will buy more normal goods and less inferior goods o Market demand cure is the horizontal sum (adds Q d at each price) of the individual demand curves Elasticity o Elastic if increase in Q d X > decrease in Px ; if MU of X decreases little and quantity consumed increases o Inelastic if MU diminishes rapidly as quantity consumed increases Value o Marginal benefit is maximum price a consumer will pay for an extra unit when utility is maximized 8. Possibilities, Preferences, and Choices Consumption choices of household are limited by budget line o Equation: Expenditure = Income = P x Q x + P y Q y Change in income changes real income, not relative price o Real income is household’s income expressed in terms of quantity of goods they can afford to buy o Relative price is price of good x divided by good y Changes rotate budget line (inc/dec slope) Preferences o Indifference curve shows combination of goods among which a person is indifferent o Marginal rate of substitution is rate at which household is willing to give up one good in exchange for another Steep IC = high MRS – willing to give up a lot of y for 1 x Diminishing MRS: tendency of a person to give up less of y for 1 x as quantity of x increases. o Substitutes have straighter IC; complements have l-shaped IC Prediction o Best affordable point occurs where IC and budget line intersect o Price effect : effect of change in price on quantity consumed o Income effect : higher income shifts demand curve right (normal goods) o Substitution effect : decrease in price leads to increase in consumption of good
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o Labor supply predictions can be made using a income-time budget line (work v. leisure) 9. Organizing Production A firm hires factors of production and organizes factors to produce goods/services o Goal is to maximize profit o Opportunity costs include implicit costs (not paid in money, i.e. time) and explicit costs (paid in money, i.e. resources) Implicit costs include: Implicit rent rate of capital is the cost of using one’s own capital Cost of owner’s resources = normal profit: expected return on average o TP = TR – TC economic profit = total revenue – opportunity cost o
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Midterm II Study Guide - Econ Study Guide Midterm II 7...

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