Economics Test 2 Review

Front 1

The demand curve for an inferior good is __________ sloping while the demand curve for a Giffen good is __________ sloping.

Back 1

downward, upward

Hint 1

The demand curve for an inferior good is downward sloping while the demand curve for a Giffen good is upward sloping. The demand curve for both inferior goods and normal goods is downward sloping which indicates that consumers will buy more units of both as the price falls. A Giffen good is a type of good that consumers will buy less of when price falls, which in turn makes the demand curve upward sloping. For a Giffen good to exist, the income effect has to be larger than the substitution effect. For this to occur the good must be an inferior good that consumes a large fraction of a consumer’s budget. For example, a poor family that spends most of their budget on rice since it will provide enough calories to survive may consume less rice if the price falls since they can now allot some of their budget to other normal goods such as chicken. In this case, the demand curve for rice would be upward sloping.

Front 2

If the cross-price elasticity of demand between two products is -3.0, then the two products are:

Back 2

complements

Hint 2

If the cross-price elasticity of demand between two products is -3.0, then the two products are complements. When two products are complements, or goods that are consumed together, when the price of one good increases the demand for the other good will fall. Therefore any negative relationship indicates the goods are complements. Substitute goods will have a direct relation between the price of one good and the demand for the other. And if the goods are not related there should be no change in the quantity demanded for one good due to a price change in the other good.

Front 3

The optimal combination of pizza and coke is the one where the:

Back 3

marginal benefit per dollar spent on pizza equals the marginal benefit per dollar spent on coke

Hint 3

The optimal combination of pizza and coke is the one where the marginal benefit per dollar spent on pizza equals the marginal benefit per dollar spent on coke. You want to spend your next dollar on the good that delivers the highest benefit for that dollar. Therefore, the optimal combination of pizza and coke will occur at the point where the marginal benefit from spending that next dollar will be equivalent. Otherwise, you could increase total benefit more by buying the good that generates the higher benefit if you spend that dollar. You cannot simply look at the highest marginal benefit without factoring in cost. This gives you a “bang for the buck” measure.

Front 4

According to this graph, how much is the total consumer surplus in this market?

Back 4

$30

Hint 4

According to this graph, the total consumer surplus in this market is $30. The market consumer surplus equals the sum of the individual consumer surpluses obtained by all consumers in the market. So, the total consumer surplus equals $12 (Juan) + $9 (Tupak) + $6 (Thurl) + $3 (Forest) = $30.

Front 5

The budget line shows:

Back 5

the affordable combinations of goods and services you can buy with your income

Hint 5

The budget line shows the affordable combinations of goods and services you can buy with your income. The budget line delineates a person’s budget constraint given current income and prices of the goods and services they consume. Each point on the line represents a different consumption bundle that fully exhausts income. Any consumption bundles that lie above the budget line are unattainable given the current income and prices of goods and services.

Front 6

According to the table, the total benefit derived from consuming three ice cream cones equals:

Back 6

24

Hint 6

According to the table, the total benefit derived from consuming three ice cream cones equals 24. You derive 18 units of benefit from consuming the first two ice cream cones and an additional 6 units of benefit when you consume the third ice cream cone. Therefore, your total benefit from consuming the three ice cream cones is 18 + 6 = 24 units of benefit of satisfaction.

Front 7

Consumer optimizing requires that the consumer:

Back 7

maximize total benefit, subject to an income constraint

Front 8

If the price of Good A rises, other things being constant, then the marginal benefit:

Back 8

per dollars worth of Good A falls

Hint 8

If the price of Good A rises, other things being constant, then the marginal benefit per dollar’s worth of Good A falls. As the price goes up the cost per additional unit of benefit of consuming Good A increases. So, the marginal benefit per dollar spent will decline accordingly. In other words, you will have to spend more money on Good A to get the same benefit.

Front 9

Considering the Law of Demand, when you compute a price elasticity of demand the answer is always:

Back 9

negative

Hint 9

When you compute a price elasticity of demand the answer is always negative. According to the law of demand when we increase the price of a product the quantity demanded will fall, or vice versa. As with any fraction when the numerator and denominator have opposite signs the fraction will be negative. Since we know it will always be negative we commonly refer to elasticity coefficients in absolute value terms. If the absolute value is greater than one it is elastic, or the quantity demanded is very responsive to a change in price.

Front 10

An increase in the price of a substitute for iPads will lead to __________ in the quantity demanded of iPads so the cross-price elasticity of demand will be __________.

Back 10

an increase, positive

Hint 10

An increase in the price of a substitute for iPads will lead to an increase in the quantity demanded of iPads so the cross-price elasticity of demand will be positive. When the substitute good increases in price (+) it will result in people switching and buying iPads instead of the substitute good. This will also be an increase so the overall cross-price elasticity will be positive. Complementary goods would result in negative cross-price elasticity and a decrease in quantity demanded as a result of a price increase.

Front 11

If the total benefit increases with additional consumption of a good, then the marginal benefit is:

Back 11

positive

Hint 11

If the total benefit increases with additional consumption of a good, then the marginal benefit is positive. The marginal benefit is the benefit gained from the consumption of the next unit of a good or service. Total benefit is the overall benefit derived from all consumption. Therefore, if total benefit increases due to the consumption of one more unit then the marginal benefit of that good must be positive. If the marginal benefit was negative, the total benefit would decline. If the marginal benefit was zero, the total benefit would remain the same.

Front 12

If a 20 percent increase in the price of Red Bull energy drinks results in a decrease in quantity demanded of 25 percent, we say the demand for Red Bull is __________ in this range.

Back 12

elastic

Hint 12

If a 20 percent increase in the price of Red Bull energy drinks results in a decrease in quantity demanded of 25 percent, we say the demand for Red Bull is elastic in this range. The price elasticity of demand is equal the percentage change in quantity demanded divided by the percentage change in price so: -25/20 = -1.25 Red Bull is considered elastic since the absolute value of the coefficient exceeds one. If it were inelastic the absolute value would be below one and unit elasticity occurs at the point where the absolute value is exactly equal to one.

Front 13

The difference between the highest price a consumer is willing to pay and the amount a consumer actually pays for a good or service is known as:

Back 13

consumer surplus

Hint 13

The difference between the highest price a consumer is willing to pay and the amount a consumer actually pays for a good or service is known as consumer surplus. Consumer surplus is maximized in perfectly competitive markets. Producer surplus is the difference between the lowest price a producer would be willing to accept for a good or service and the price the producer actually receives. Equilibrium occurs at the point where the quantity demanded is exactly equal to the quantity supplied.

Front 14

If the total benefit increases with additional consumption of a good, then the marginal benefit is:

Back 14

positive

Hint 14

If the total benefit increases with additional consumption of a good, then the marginal benefit is positive. The marginal benefit is the benefit gained from the consumption of the next unit of a good or service. Total benefit is the overall benefit derived from all consumption. Therefore, if total benefit increases due to the consumption of one more unit then the marginal benefit of that good must be positive. If the marginal benefit was negative, the total benefit would decline. If the marginal benefit was zero, the total benefit would remain the same.

Front 15

Along a linear demand curve, the slope __________ while the price elasticity of demand __________.

Back 15

is constant, changes from one point to another

Hint 15

Along a linear demand curve, the slope is constant while the price elasticity of demand changes from one point to another. The price elasticity of demand and the slope of the line are two different things. The slope will not change for a linear function but the elasticity depends on what point on the line you choose to calculate the elasticity. As you move upward on a linear curve the price elasticity of demand will increase in absolute value.

Front 16

The total benefit of consuming two slices of pizza is the:

Back 16

total satisfaction you get from consuming the two slices of pizza

Hint 16

The total benefit of consuming two slices of pizza is the total satisfaction you get from consuming the two slices of pizza. In economics, the concept of benefit refers to the satisfaction or enjoyment received from consuming some good or service. So, total benefit is equivalent to total satisfaction. The satisfaction received from consuming one more unit of some good is marginal benefit.

Front 17

The more substitutes that exist for a particular product, the __________ the price elasticity of demand.

Back 17

greater

Hint 17

The more substitutes that exist for a particular product, the greater the price elasticity of demand. Consumers are much more likely to switch consumption when the price increases if there is another product that can be rapidly substituted. For example, if beef increases in price consumers can switch to chicken or pork. The availability of these substitutes make beef more elastic than it would be if there were no protein alternatives.The more horizontal the demand curve the more elastic the good.

The more vertical the demand curve the more inelastic the good.

Front 18

Suppose you have a fixed amount of income and spend equal amounts on two goods, X and Y. The price of good X is Px = $10, and the price of good Y is Py = $5. The marginal benefit of X is MBx = 60 units of benefit, and the marginal benefit of Y is MBy = 15 units of benefit. How should the consumption of X and Y change, if at all, to increase benefit?

Back 18

Consumption of good X should increase, and consumption of good Y should decrease.

Hint 18

Suppose you have a fixed amount of income and spend equal amounts on two goods, X and Y. The price of good X is Px = $10, and the price of good Y is Py = $5. The marginal benefit of X is MBx = 60 units of benefit, and the marginal benefit of Y is MBy = 15 units of benefit. Consumption of good X should increase, and consumption of good Y should decrease in order to increase benefit. One dollar spend on good X generates 6 units of benefit (i.e., 60 units of benefit / $10 = 6 units of benefit per dollar). Conversely, one dollar spent on good Y generates only 3 units of benefit (i.e., 15 units of benefit / $5 = 3 units of benefit per dollar). Therefore, you can increase total benefit by reducing the amount spent on good Y and spending that amount on good X.

Front 19

Economists avoid confusion over units in the computation of elasticity by using:

Back 19

percentage changes

Hint 19

Economists avoid confusion over units in the computation of elasticity by using percentage changes. Using percentage changes eliminates the problem of the elasticity coefficient differing simply due to changing the unit of measurement. For example, we would have a different elasticity for the same price change simply by using dollars instead of cents. Using the percentage change avoids this problem.

Front 20

What is the cross-price elasticity of demand for two goods that are unrelated?

Back 20

Zero

Hint 20

The cross-price elasticity of demand for two goods that are unrelated is zero. If the two products are unrelated then a change in the price of one product will have no impact on the quantity demanded of the other good. When the numerator is equal to zero the elasticity coefficient will always be zero.

Front 21

If the price of Good A rises, other things being constant, then the marginal benefit:

Back 21

per dollar’s worth of Good A falls

Hint 21

If the price of Good A rises, other things being constant, then the marginal benefit per dollar’s worth of Good A falls. As the price goes up the cost per additional unit of benefit of consuming Good A increases. So, the marginal benefit per dollar spent will decline accordingly. In other words, you will have to spend more money on Good A to get the same benefit.