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MICROECONOMICS FINAL EXAM QUESTIONS & ANSWERS

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Scarcity - ANSWERSMoney, time, the capacity of your stomach... Different resources can become scarce in difference scenarios. Coping with scarcity is the essence of the human condition. Microeconomics can simply be defined as the subject about coping with scarcity. More formally: microeconomics ...

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MICROECONOMICS FINAL EXAM
QUESTIONS & ANSWERS
Scarcity - ANSWERSMoney, time, the capacity of your stomach... Different resources
can become scarce in difference scenarios.

Coping with scarcity is the essence of the human condition. Microeconomics can simply
be defined as the subject about coping with scarcity. More formally: microeconomics is
the study of how people choose under conditions of scarcity.
- For someone with an infinite lifetime and limitless material resources, hardly a single
decision would ever matter. If you made a bad decision today, you could always start
with a clean slate tomorrow.

AnswerCost-Benefit Approach - ANSWERS*Should I do activity x?*
x = watch an NBA game, eat another lobster, ...

*The decision rule:* If B(x) > C(x), do x; otherwise don't.
- *B(x)* = benefits of doing x and C(x) = costs.
- We define B(x) as the maximum dollar amount you would be willing to pay to do x.
- *C(x)*, in turn, is the value of all the resources you must give up in order to do x.
- the value of the painful feeling of giving up the graduation ceremony; what is your
willingness to pay for giving up the graduation ceremony
- If B(x) and C(x) happened to be equal, you would be indifferent between the two
alternatives.

Example: Should I turn off the unnecessary alarm that I forgot to deactivate last night?
- The benefit of turning it off is not having to listen to it while you want to sleep for
another 15 minutes or 2 hours. The cost, in turn, is the inconvenience of getting out of
your bed. If you put your phone away in another room (C(x) large) and had ear plugs
(B(x) small), you will probably stay put. But if you are extremely sensitive to noise (B(x)
large), you are more likely to get up and turn off the alarm.

AnswerOpportunity Costs - ANSWERS*What is the true cost of college?*
- College costs are not limited to explicit costs such as tuition, fees, housing, food,
books, supplies, and the like. They also include the opportunity cost of earnings forgone
while studying.

,*What is the true cost of a takeaway meal?*
- It certainly include the explicit cost you pay for the takeaway. It should also include the
opportunity cost of the net benefit you derive from having a restaurant meal.

AnswerMarginal Analysis - ANSWERSA lot of the questions we study in this course is
concerned with activities at the margin.
- Should I spend one more hour to study microeconomics?
- Should the factory manager increase the output level by 1 unit?
- So, instead of asking "Should I do activity x?," we repeatedly pose the question
"Should I increase the level by which I am currently engaging in activity x?"

To answer this question, we must compare the benefit and cost of an additional unit of
activity. The cost of an additional unit of activity is called the *marginal cost* of the
activity, and the benefit of an additional unit is called its *marginal benefit.*

Decision rule is the same: If MB(x) > MC(x), do it; otherwise don't.

Abuse the notation x to denote the level of activity x.

AnswerMarginal Analysis and Optimization - ANSWERSWhen MB(x) = MC(x), the
agent will stop changing x, the level of the activity. Under regularity conditions, the x that
makes the equality hold is optimal in the sense that it will maximize the overall net
benefit for the agent.
- Example: Each slice of pizza costs $3. The marginal satifaction of having one slice of
pizza for Bob is equivalent to $5 for the first slice, $3 for the second slice, $1 dollar for
the third slice, and -$1 for the fourth slice. How many slices should Bob eat?
•The optimal number of slices is two, because MB(2) = $3 = MC(2).

We will study optimization questions like
- The optimal consumption bundle of food and clothing for a consumer
- The optimal input bundle of labor and capital for a producer
We will see that the optimal condition is exactly MB=MC.

The point is that although it may appear that we never do optimization problems in our
real life, we are actually doing it every time we compare marginal benefit and marginal
cost to make a marginal decision.

AnswerWhat is Microeconomics? - ANSWERSBranch of economics that deals with the
behavior of individual economic units—consumers, firms, workers, and investors—as
well as the markets that these units comprise.

The study of individual choices and the study of group behavior in individual markets
both come under the rubric of microeconomics.

,•Macro is more complex, its issues tend to generate more disagreements among
economists, and are more influential since the scale of the issues. But economists
increasingly believe that the key to progress in macroeconomics lies in more careful
analysis of the individual markets that make up broader aggregates.
- As a result, the distinction between micro and macro has become less clear in recent
years. The graduate training of all economists, micro and macro alike, is increasingly
focused on microeconomic analysis.

AnswerMacroeconomics - ANSWERSBranch of economics that deals with aggregate
economic variables, such as the level and growth rate of national output, interest rates,
unemployment, and inflation.

AnswerWhy Study Microeconomics? - ANSWERSIt trains you to think like an
economist.
- This means a deeper and more systematic understanding of the issues around you.
Become an "economic natalist".
- By having a better understanding, you can make better decisions.

Example: Why do many manual transmissions have six forward speeds, many
automatics only four?
- The more forward speeds a car's transmission has, the better its fuel economy will be.
- Automatic transmissions are more complex than manual ones, and the cost of adding
an extra speed is accordingly much greater in automatics.

Learning economics enables you to become an *"economic naturalist"*, a person who
sees the mundane details of ordinary existence in a sharp new light.

AnswerDemand Curve - ANSWERSDescribes the relationship between the quantity of
a good demanded by consumers (Qd) and the price of the good (P).

AnswerHorizontal Interpretation - ANSWERShow much of a product consumers wish to
purchase at various prices.

*Demand Function*

*Qd=Qd(P)*

AnswerVertical Interpretation - ANSWERSHow much the marginal consumers are
willing to pay at various quantities (i.e. reservation price)

*Inverse Demand Function*
- The inverse demand function is consistent with the algebraic convention of putting the
value of a function on the vertical axis. "y=f(x)"

*P=P(Qd)*

, AnswerDemand Schedule - ANSWERSthe discrete version of a demand curve.

AnswerThe Law of Demand - ANSWERSThe empirical observation that when the price
of a product falls, people demand larger quantities of it.
- Upward sloping demand curve is possible but rare. (Giffen good)

Two reasons for law of demand: As price rises,
1. People switch to a close substitute; (*substitution effect*)
- P increases, less real income
2. People are not able to buy as much as before. (*income effect*)

The demand curve for a good is a summary of the various cost-benefit calculations that
buyers make with respect to the good. (consumer theory)
- Cost = price; benefit = satisfaction provided by the product.
- The cost-benefit criterion will be met for fewer and fewer potential buyers as the price
of the product rises.

AnswerSupply Curve - ANSWERSDescribes the relationship between the quantity of a
good supplied by producers and the price of the good.

AnswerHorizontal Interpretation (Supply) - ANSWERSHow much of a product
producers wish to sell at various prices.

*Supply Function*

*Qs=Qs(P)*

AnswerVertical Interpretation (Supply) - ANSWERSHow much the marginal producers
are willing to sell at various quantities (i.e. reservation price to sell)

*Inverse Supply Function*

*P=P(Qs)*

AnswerThe Law of Supply - ANSWERSThe empirical observation that when the price
of a product rises, firms offer more of it for sale.

The two reasons for the law of supply:
- The cost of producing additional units often tends to rise as more units are produced,
especially in the short run.
- As price rises, more producers join the industry (substitution)

The supply curve for a good is a summary of the various cost-benefit calculations that
sellers make with respect to the good. (firm theory)
- Cost = production cost; benefit = price

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