ECON2200 Exam 2 Study Guide

Law of Supply

A principle in economics that states that as the price of a good, service, or resource rises, the quantity supplied will increase, and vise versa, all else held constant
(Price and quantity supplied have a direct relationship)

What factors cause a supply curve to shift (& in which direction)

Expectations about market conditions
The number of sellers
Input Prices
Prices of related goods
Expected Price
Number of Firms
Weather/Natural Events
A graphical representation of the relationship between the price of a good, service, or resour

Equilibrium Price and Quantity

A state of equilibrium occurs when the market price and quantity remain constant

Impact of Price Ceilings

By placing a price ceiling on a good in a market it keeps prices low despite what demand for the product may be. Often results in a shortage.

Impact of Price Floors

Price Floors often result in a surplus because prices must be kept above a certain price despite what demand is.

Impact of Quotas

A restriction on the amount that can be produced. This is often done with regard to international trade

Consumer Surplus

The difference between the maximum price consumers are willing and able to pay for a good or service and the price they actually pay. Consumer surplus also can be thought of as the wealth that trade creates for consumers in a market. MEASURED IN DOLLARS!!

Producer Surplus

The difference between the price producers receive for good or service and the minimum price they are willing and able to except. Producer surplus also can be thought of as the wealth that trade creates for producers in a market.MEASURED IN DOLLARS!!!

Deadweight Loss

The value of the economic surplus that is forgone when a market is not allowed to adjust to its competitive equilibrium


How responsive the amount we want to buy is to a change in the price level

4 types of elasticity & their coefficients

1. Pice elasticity of demand = Ed
2. Cross price elasticity of demand = Exy
3. Income elasticity of demand = Ei
4. Price elasticity of supply = Es

5 determinants of price elasticity of demand

The price of the good or service.
Prices of related goods or services. These are either complementary (purchased along with) or substitutes (purchased instead of).
Income of buyers.
Tastes or preferences of consumers.


Costs or benefits of market transactions not reflected in prices...-A third party is affected by production or consumption-Benefits or costs to the third party not considered by buyers or sellers

Role of government in a market economy

Provide a stable set of institutions and rules...
-Enforce contracts
Establish and enforce laws
Promote competition...
-Preventing excess monopoly power
Provide for Public Goods...
-Public Good: things like national defense, air, water and public lands su

Public Goods

Goods, such as clean air and clean water, that everyone must share.

Private Goods

Goods that are both excludable and rival in consumption (not shared)

Free Rider Problem

If the private sector tries to supply public goods we get an under-provision of the good. Nobody wants to pay for a good that anybody can consume for free.Therefore, the government tends to provide public goods by using tax money (we all pay).Example: Par

internalizing an externality

Marginal private benefit or cost of goods and services are adjusted so that users consider the actual marginal social benefit or cost of their decisions.
Negative externality - MEC is added to MPC
Positive externality - MEB is added to MPB

Coase Theorem

Governments, by merely establishing rights to use resources, can internalize externalities when transactions costs of bargaining are zero.
Users initially granted the right are better off, because they own a valuable property right that can either be used

Tragedy of the Commons

Written by Garrett Hardin -a trained biologist. (Science, 12/13/68)
The "Tragedy" refers to the over-usage of commonly owned goods.Examples:
-Grazing on public lands
-Litter on public property

Why are free riders a common problem for public goods?

Public goods are non-excludable and therefore people do not have to pay for the good to use it

When the use of a communally owned resource has no price, then people will

Use too much of this resource

It is the custom for paper mills located alongside the Layzee River to discharge waste products into the river. As a result, operators of hydroelectric power-generating plants downstream along the river find that they must clean up the river's water befor

Levy a tax on the producers of paper products and use the tax revenues to clean up the river

When producers do not have to pay the full cost of producing a product, they tend to

Overproduce the product because of a negative externality.

Why is the marginal benefit of cleaning up pollution downward sloping?

At first cleaning pollution makes a big difference but there are diminishing marginal returns for subsequent efforts.

Which of the following situation would make transaction costs too high to negotiate and therefore the Coase Theorem would not apply?

Many firms are in the area with different levels of pollution

Why do private companies rarely provide public goods?

There is no way to force people to pay for the public good which increases free riders.

The Coase Theorem works because the negotiation

Makes both parties better off.

Why might it be hard for companies to know how much pollution should be cleaned up?

Many costs of pollution are hard to see or itemize to get an accurate amount of the true cost.

When the free-rider problem occurs in a market for a good, what is true of the quantity of the good supplied relative to the efficient quantity of the good?

The good is typically undersupplied in a market where the free-rider problem occurs.

The intention of a price ceiling is to help consumers by forcing a price that is below the equilibrium price. What is one unintended consequence of this policy?

Consumers face a shortage of the good and decreased consumer surplus.

Why does consumer surplus decrease when price increases?

Consumers buy less of the good at a higher price.

Why does producer surplus decrease as price decreases?

Producers sell less of the good and receive less from the lower price.

A government-imposed price ceiling has what effect on efficiency?

Consumer surplus increases.

The intention of a price floor is to help producers by setting a higher than equilibrium price. What is one unintended consequence of this policy?

Economic surplus decreases.

A government-imposed price floor has what effect on efficiency?

Producer surplus increases.

The concept of price elasticity of demand measures the

Sensitivity of consumer purchases to price changes.

The price elasticity of demand is a measure of the

responsiveness of buyers of a good to changes in its price.

Assume that a 3% increase in income across the economy produces a 1% decrease in the quantity of fast food demanded. The income elasticity of demand for fast food is ____________, and therefore fast food is _______________

Negative; an inferior good

The price elasticity of demand is negative because of

the law of demand.

Which of the following would cause a rightward shift of the supply curve for cell-phone services?

a subsidy to cell-phone producers

The law of supply indicates that, all else held constant,

producers will be willing and able to offer more of a product at high prices than at low prices.

The upward slope of the supply curve reflects the

principle of diminishing marginal productivity

An improvement in production technology will

shift the supply curve to the right.

The internet has changed how people shop for clothes, electronics, and other goods. Because of online shopping, many retailers have closed or shut down. How will this affect the local (brick and mortar) retail market for clothes?

The supply of goods like clothes will decrease.

All else held constant, if farmers receive a subsidy for their corn, then this would cause a

rightward shift in the current supply of corn.

Percent Change Formula

((Original Quantity-New Quantity)/(Original Price-New Price))
Original Price/Original Quantity