Review for Exam 1 Chapters 1 Through 5

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Production possibilities frontier (PPF) A curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology. Opportunity cost The highest-valued alternative that must be given up to engage in an activity.

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Graphing the Production Possibilities Frontier FIGURE 2-1 BMW’s Production Possibilities Frontier

Production Possibilities Frontiers and Opportunity Costs Learning Objective 2.1 Economic Growth FIGURE 2-3 Economic Growth Economic growth The ability of the economy to produce increasing quantities of goods and services.

Learning Objective 2.2 Comparative advantage The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors. Absolute Advantage versus Comparative Advantage Comparative Advantage and Trade Absolute advantage The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources

Comparative Advantage and Trade Learning Objective 2.2 Trade The act of buying or selling. Specialization and Gains from Trade FIGURE 2-4 Production Possibilities for You and Your Neighbor, without Trade

Learning Objective 2.2 Specialization and Gains from Trade TABLE 2-1 A Summary of the Gains from Trade Comparative Advantage and Trade YOUYOUR NEIGHBOR APPLES (IN POUNDS) CHERRIES (IN POUNDS) APPLES (IN POUNDS) CHERRIES (IN POUNDS) Production and consumption without trade Production with trade Consumption with trade Gains from trade (increased consumption)2313

Learning Objective 2.2 Solved Problem 2-2 Comparative Advantage and the Gains from Trade BEFORE TRADEAFTER TRADE HONEY (IN TONS) MAPLE SYRUP (IN TONS) HONEY (IN TONS) MAPLE SYRUP (IN TONS) CANADA UNITED STATES CANADAUNITED STATES HONEY (IN TONS) MAPLE SYRUP (IN TONS) HONEY (IN TONS) MAPLE SYRUP (IN TONS)

Learning Objective 2.3 Property rights The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it. The Legal Basis of a Successful Market System The Market System Protection of Private Property Enforcement of Contracts and Property Rights If property rights are not well enforced, fewer goods and services will be produced. This reduces economic efficiency, leaving the economy inside its production possibilities frontier.

– Perfectly competitive market A market in which there are many buyers and sellers, all the products are identical, and there are no barriers to new sellers entering the market. Where Prices Come From: The Interaction of Demand and Supply Law of demand Holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease.

The Demand Side of the Market Learning Objective 3.1 FIGURE 3-2 Shifting the Demand Curve Holding Everything Else Constant: The Ceteris Paribus Condition

The Demand Side of the Market Learning Objective 3.1 Variables That Shift Market Demand TABLE 3-1 Variables That Shift Market Demand Curves

The Demand Side of the Market Learning Objective 3.1 Variables That Shift Market Demand TABLE 3-1 Variables That Shift Market Demand Curves (continued)

The Supply Side of the Market Law of supply Holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied. Learning Objective 3.2 The Law of Supply

The Supply Side of the Market Learning Objective 3.2 FIGURE 3-5 Shifting the Supply Curve The Law of Supply

The Supply Side of the Market Learning Objective 3.2 Variables That Shift Supply TABLE 3-2 Variables That Shift Market Supply Curves

The Supply Side of the Market Learning Objective 3.2 TABLE 3-2 Variables That Shift Market Supply Curves (continued) Variables That Shift Supply

Market Equilibrium: Putting Demand and Supply Together FIGURE 3-7 Market Equilibrium Learning Objective 3.3

The Effect of Demand and Supply Shifts on Equilibrium FIGURE 3-9 The Effect of an Increase in Supply on Equilibrium The Effect of Shifts in Supply on Equilibrium Learning Objective 3.4

The Effect of Demand and Supply Shifts on Equilibrium FIGURE 3-10 The Effect of an Increase in Demand on Equilibrium The Effect of Shifts in Demand on Equilibrium Learning Objective 3.4

Consumer surplus The difference between the highest price a consumer is willing to pay and the price the consumer actually pays. Marginal benefit The additional benefit to a consumer from consuming one more unit of a good or service. Consumer Surplus and Producer Surplus Learning Objective 4.1 Producer surplus The difference between the lowest price a firm would have been willing to accept and the price it actually receives. Marginal cost The additional cost to a firm of producing one more unit of a good or service.

The Efficiency of Competitive Markets FIGURE 4-6 Economic Surplus Equals the Sum of Consumer Surplus and Producer Surplus Economic Surplus Learning Objective 4.2 Economic surplus The sum of consumer surplus and producer surplus.

Learning Objective 4.1 Consumer surplus measures the net benefit to consumers from participating in a market rather than the total benefit. The net benefit equals the total benefit received by consumers minus the total amount they must pay to buy the good. Producer surplus measures the net benefit received by producers from participating in a market, or the total amount firms receive from consumers minus the cost of producing the good. What Consumer Surplus and Producer Surplus Measure Consumer Surplus and Producer Surplus

The Efficiency of Competitive Markets FIGURE 4-7 When a Market Is Not in Equilibrium There is a Deadweight Loss Deadweight Loss Deadweight loss The reduction in economic surplus resulting from a market not being in competitive equilibrium. Learning Objective 4.2

The Efficiency of Competitive Markets Economic efficiency A market outcome in which 1)the marginal benefit to consumers of the last unit produced is equal to its marginal cost of production and 2)the sum of consumer surplus and producer surplus is at a maximum. Economic Surplus and Economic Efficiency Learning Objective 4.2

Government Intervention in the Market: Price Floors And Price Ceilings FIGURE 4-8 The Economic Effect of a Price Floor in the Wheat Market Price Floors: Government Policy in Agricultural Markets Learning Objective 4.3

Government Intervention in the Market: Price Floors And Price Ceilings FIGURE 4-9 The Economic Effect of a Rent Ceiling Price Ceilings: Government Rent Control Policy in Housing Markets Learning Objective 4.3

The Economic Impact of Taxes The Effect of Taxes on Economic Efficiency FIGURE 4-10 The Effect of a Tax on the Market for Cigarettes Learning Objective 4.4

The Economic Impact of Taxes Tax Incidence: Who Actually Pays a Tax? Tax incidence The actual division of the burden of a tax between buyers and sellers in a market. Learning Objective 4.4

The Economic Impact of Taxes Tax Incidence: Who Actually Pays a Tax? Determining Tax Incidence on a Demand and Supply Graph FIGURE 4-11 The Incidence of a Tax on Gasoline Learning Objective 4.4

– Externality A benefit or cost that affects someone who is not directly involved in the production or consumption of a good or service. Externalities, Environmental Policy, and Public Goods

Learning Objective 5.1 – Private cost The cost borne by the producer of a good or service. – Social cost The total cost of producing a good, including both the private cost and any external cost. – Private benefit The benefit received by the consumer of a good or service. – Social benefit The total benefit from consuming a good or service, including both the private benefit and any external benefit. Externalities and Economic Efficiency The Effect of Externalities

Learning Objective 5.1 Externalities and Economic Efficiency The Effect of Externalities FIGURE 5-1 The Effect of Pollution on Economic Efficiency How a Negative Externality in Production Reduces Economic Efficiency

Learning Objective 5.1 Externalities and Economic Efficiency How a Positive Externality in Consumption Reduces Economic Efficiency FIGURE 5-2 The Effect of a Positive Externality on Efficiency

Learning Objective 5.1 Externalities and Economic Efficiency Externalities May Result in Market Failure Market failure A situation in which the market fails to produce the efficient level of output. What Causes Externalities? Property rights The rights individuals or businesses have to the exclusive use of their property, including the right to buy or sell it.

Private Solutions to Externalities: The Coase Theorem Learning Objective 5.2 The Coase Theorem Transactions costs The costs in time and other resources that parties incur in the process of agreeing to and carrying out an exchange of goods or services. The Problem of Transactions Costs Coase theorem The argument of economist Ronald Coase that if transactions costs are low, private bargaining will result in an efficient solution to the problem of externalities.

Learning Objective 5.3 Pigovian taxes and subsidies Government taxes and subsidies intended to bring about an efficient level of output in the presence of externalities. Command and Control versus Tradable Emissions Allowances Command and control approach An approach that involves the government imposing quantitative limits on the amount of pollution firms are allowed to emit or requiring firms to install specific pollution control devices. Government Policies to Deal with Externalities

Learning Objective 5.3 FIGURE 5.5 When There Is a Negative Externality, a Tax Can Bring about the Efficient Level of Output

Government Policies to Deal with Externalities Learning Objective 5.3 FIGURE 5.6 When There Is a Positive Externality, a Subsidy Can Bring about the Efficient Level of Output

Learning Objective 5.3 Command and Control versus Tradable missions Allowances FIGURE 5.7 Estimated Cost of the Acid Rain Program in 2010 Government Policies to Deal with Externalities

Learning Objective 5.4 FIGURE 5.8 Four Categories of Goods

Learning Objective 5.4 FIGURE 5.10 Constructing the Market Demand Curve for a Public Good Four Categories of Goods The Demand for a Public Good

Four Categories of Goods Learning Objective 5.4 FIGURE 5.11 The Optimal Quantity of a Public Good

Learning Objective 5.4 Four Categories of Goods Common Resources Tragedy of the commons The tendency for a common resource to be overused. FIGURE 5.12 Overuse of a Common Resource