Microeconomics Review Workbook By Mike FladlienWant more review? Checkout my iPod App, Econexamcram on the iTunes Store. 1 For Hose, Want more review? Checkout my iPod App, Econexamcram on the iTunes Store. 2 Contents Production Possibilities Perfect Competition Monopoly Elasticity Production Costs Externalities Basic Macro Concepts AD/AS AS LRS 4 9 16 24 33 40 45 56 62 66 Want more review? Checkout my iPod App, Econexamcram on the iTunes Store. 3 Econexamcram on the iTunes Store. Quantity 1 2 3 4 5 6 7 8 9 10 Labor Used 5 12 15 26 36 45 56 71 92 122 a. b. washers and dryers. What’s the opportunity costs of the eight worker? _________ c.Production Possibilities Problem PPF1 (3) Name ___________________ For the economy of Alpha. Draw the new curve to show the increase in labor and label it PPC1. Suppose immigration from Mexico brings in 21 more workers. there are 71 units of unskilled labor used to make two goods. 4 . Draw the new curve and label it PPC2. Draw the production possibilities curve for an economy with 71 labor units and label it PPC0. d. Want more review? Checkout my iPod App. Suppose technology changes so that productivity increases the 92 labor force to an equivalent of 122. straight line. Econexamcram on the iTunes Store. Want more review? Checkout my iPod App. how many sheep can he sheer? _______ b. In one hour. The costs increase to 3/5. If Billy Bob just shucks corn. The cost of 5 tubs of butter is 2/5 guns. how many bushels can be shuck? ________ c. she gives up one cupcake. Problem PPF2 (0) Billy Bob can either sheer sheep or shuck corn equally well. What you give up is “opportunity cost”. If Lucy decides to make muffins. and 7/1. Lucy’s production possibilities curve would be a constant cost. These resources are perfect substitutes. Lucy has a constant cost of making cupcakes of one muffin. and 2 eggs. cake mix. If Lucy decides to make 5 cupcakes. This is shown graphically below. With these inputs. What’s the opportunity cost of shucking one bushel of corn?_____ Sheering one sheep? _____ Sample Problem 3 – Increasing Opportunity Cost In Buffoonia. Likewise. If Lucy makes one ore cupcake or 2. she can either make 10 cupcakes or 10 muffins. If Billy Bob just sheers sheep. 5 . The PPF schedule and graph shows the transformation. then she can only make 3 muffins. Buffoonia must give up more and more guns to get additional tubs of butter. 8/5. Suppose Lucy is making 1 cupcake and 4 muffins. he can sheer 20 sheep or shuck 20 bushels of corn. from 10 muffins to 10 cupcakes.Sample Problem 2 – Perfectly substitutable resources. then she gives up 5 muffins. Suppose that Lucy has baking flour. Draw Billy Bob’s PPF below. guns can be transformed into butter. a. Lucy has a constant cost of 1 muffin. On the other hand. Sample Problem 4 – Efficiency Efficiency is shown on the PPF as any point on the boundary. Answer the questions that follow: a. What’s the opportunity cost of making the third Wang? b. if the owner only had 5 songs total. Want more review? Checkout my iPod App. This is so because one would have to give up some of Good X to get more of Good Y. The embedded graph shows an inefficient point inside the PPF. the owner would have to give up one Rap song to make room for one more Classical song. If the owner of the iPod had 50 Rap and 50 Classical songs. Explain why the resources used in making Wonks and Wangs are not perfectly substitutable. At 4 MP3 players and 2 cell phones. then she could add more of both songs. Only when something must be given up to get more of another are the resources efficient. c. 6 . Econexamcram on the iTunes Store.Problem PPF3 (0) Willy Wonka can transform Wanks into Wongs as shown below. the user could have enjoy more of either good without opportunity cost. Think of an iPod that holds 100 songs. Show how the opportunity cost increases as additional Wangs are produced. assume that the two countries trade 2:1. Explain why you might disagree with her. could he paint more watercolors without giving up any oil paintings? ______________ c. Answer the questions that follow. ______________ Problem PPF5 (3) Mars can make 18 Guns and 6 Roses. Point F is not obtainable by Johan.Problem PPF4 (0) Johan Cabooci can produce oil or watercolor paintings according the PPF below. Venus is making and consuming 3 Guns and 3 Roses. Johan’s girlfriend says that he should only paint oil paintings. If Johan is at Point E. identify autarky. Draw the new trading possibilities curve. and find the comparative advantage of each country. Venus can make 6 Guns and 6 Roses. Econexamcram on the iTunes Store. Currently Mars is making and consuming 9 Guns and 3 Roses. Draw their respective PPFs. Finally. Want more review? Checkout my iPod App. 7 . a. What must happen for his PPF to shift outward? ________________________________ b. labor. 8 . 1. PPF5 Want more review? Checkout my iPod App. 3 cost 3. Yes. ½ costs 5 PPF4 Increase in land. each Wang costs more. and capital. He gives up 5 oil paintings. Econexamcram on the iTunes Store.Solutions: PPF1 PPF2 20. 1 Wang costs ½ Wonk. 20. PPF3 3 Wonks. He should not just paint watercolors. 2 cost 1. and average revenue and graph the demand curve. Comp1 (0) Bill Booge sells Boogers in a perfectly competitive market. Since there are millions competing against him. Use the Market to compute total revenue. Want more review? Checkout my iPod App. weed pullers can sell their services for $2 per yard.Perfect Competition Sample 1 Name __________________________ Lee Pullem pulls weeds in the perfectly competitive dandelion removal market. Econexamcram on the iTunes Store. Lee is a price taker. In this example. marginal revenue. 9 . and perform the following tasks: A. E. A. Determine the market price B. __________ B. Econexamcram on the iTunes Store. Determine the market price B. _____ D. __________ C. ______ Want more review? Checkout my iPod App. The long-run price. _____ E. A. Determine the total cost being incurred by the firm. 10 . Determine the total cost being incurred by the firm. Compute the total revenue being earned by the firm. __________ D. D. and perform the following tasks: A. Compute the amount of profit being earned by the firm C. _____ C. D. __________ Comp3 (0) Loss Minimizing Take the data contained in the graph for the market. Compute the amount of profit being earned by the firm C. The long-run price. _____ B. __________ E. E.Comp2 (0) Take the data contained in the graph for the market. Compute the total revenue being earned by the firm. and to spammers. ______ B. Determine the total cost being incurred by the firm. D. Econexamcram on the iTunes Store. Compute the amount of profit being earned by the firm C.75 10 17. The firm sells it output at $2 per Doodle at flea markets. Complete the table. ______ E.5 TC AVC ATC AFC MC TR π Want more review? Checkout my iPod App. A. The long-run price. 11 .5 4. ______ Comp5 (2) Assume that the table below is a true and accurate picture of a perfectly competitive firm in the Doodle market. and perform the following tasks: A. Determine the market price B. Compute the total revenue being earned by the firm.Comp4 (0) Shut-down case Take the data contained in the graph for the market. E. Q 0 1 2 3 4 5 FC 4 4 4 4 4 4 VC 0 2 2. ______ C. ______ D. yard sales. and MR. AVC. MC. Use a yellow highlighter to shade the area of profit. Want more review? Checkout my iPod App.Comp6 (1) Using the quantities from Comp5. graph ATC. graph TR. 12 . Econexamcram on the iTunes Store. and TC. VC. FC. Comp7 (1) Using the quantities from Comp5. 75 10 17.” (A few hints might aid you in your discovery. look at your table from Comp5 and your graphs from Comp6 and Comp7. postulate a rule for loss minimization. Econexamcram on the iTunes Store. If the firm would shut down.Comp8 (2) Now. Comp9(0) Complete the table below.75 14 21. All of the data will look like Comp5 except total revenue.5 8.5 4.5 TR π Want more review? Checkout my iPod App. 13 . how much would it lose in fixed costs? How much does the firm lose when it operates at profit max?) Next. Explain whether you think the firm should shut down or minimize losses? _________________________________________________ Q 0 1 2 3 4 5 FC 4 4 4 4 4 4 VC 0 2 2. Explain on the yellow legal pad below why micro economists call this the “loss minimizing position. Complete the total revenue and profit columns.5 TC 4 6 6. Assume more suppliers enter the market and the price falls to 50¢. 25 2.8 TR 0 2 2 .25 1.5 TC 4 6 6. $3 Comp4 A. $ . Econexamcram on the iTunes Store. $5.75 14 21.Solutions: Comp1 Comp2 A. Shut down and lose $4 in fixed costs. -$2.5 8.5 -2.3 C.5 4.25 8 7.9 3.5 Want more review? Checkout my iPod App. C.5 10 π -4 -4 -2.5 3.5 6 5.5 6 3.58 2.5 AVC ATC AFC MC 2 1. 0 D.3 4 2 1.50 B. $12 D.25 C.7 E.5 4 2. $3 Comp5 Q 0 1 2 3 4 5 FC 4 4 4 4 4 4 VC 0 2 2.33 1 .75 -4 -11. $4 B. $5. $6. $4 E. 14 . $3 D.5 4.75 10 17.25 E. $2 Comp3 A. $2 B. Want more review? Checkout my iPod App. The rule is P > AVC to minimize losses. By producing 2.5 units all variable costs are covered and some fixed costs. Comp9 Firm should shut down since P < AVC and the losses keep mounting.Comp6 Comp7 Comp8 It’s called the loss minimizing position because some fixed costs are covered. 15 . Econexamcram on the iTunes Store. consumer’s surplus. Cathy is willing to pay $3. total cost. What will be the price the dolls sell at. 16 . and price of each doll? Four dolls will be sold at the price of $2 because that’s the resource allocative efficient price (P = MC). Want more review? Checkout my iPod App. consumer’s and producer’s surplus? Two dolls will be sold at $4 dollars. Betty is willing to pay $4. Consumer’s surplus will be $2 and producer’s surplus will be $8. what will be the total profit. total revenue.Monopoly Sample 1: Perfect Competition Name _____________________ Five friends go to an auction and see an Elvis bobble head doll. how many will be sold. and Edna is willing to pay $1 for the dolls. The auctioneer has hundreds of the dolls and they all are exactly alike. At a marginal cost of $2. Consumer’s surplus is $8 and producer’s surplus is $8. total revenue. Total revenue will be $8 and total cost will be $8 for zero profit. Sample 2: Pure Monopoly If the same five friends go to an action in which the seller has a monopoly. total cost. profit. producer’s surplus. Total revenue will be $8 and total cost $4 for a $4 profit. Alice is willing to pay $5. Econexamcram on the iTunes Store. Dolly is willing to pay $2. Want more review? Checkout my iPod App. and producer’s surplus equals $14. Shade the dead weight loss. How much is total cost at the monopoly price?____________ f. how much is consumer’s surplus?__________ j. How much profit does the monopolist earn?___________ g. Cathy Pays $3. What quantity would the monopolist sell? ___________ d. How much is total revenue at the monopoly price?____________ e. 17 . What price would this monopoly sell all of her output?________ c. Total revenue equals $14. When a monopolist is able to discriminate. profit equals $6. k. What is another name for this type of monopoly? __________________ b. This is a single-price monopoly. What price ranges are inelastic?______________ h. At the monopoly price.50. What price would allow the firm to break even?__________ m. Problem MONO1 (0) a. Why does the marginal revenue curve lie below the demand curve? _________ ______________________________________________________. At what price is the price elasticity of demand = 1?__________ i. Econexamcram on the iTunes Store.Sample 3 Price Discriminating Monopoly A price discriminating monopolist can sell the same product at different prices. What price would a perfect competitor charge?___________ l. profits are maximized and all surplus is captured by the producer. In this case. and Dolly pays $2. consumer’s surplus equals $0. Betty pays $4. Alice pays $5. total cost equals $8. The ride which simulates a rollercoaster ride through the Himalayas is popular in rural towns in Iowa. copyright or legal right to be the sole producer of the good. They have the patent on the ride. _________ If this were a perfectly competitive firm. S. A monopoly might be large enough that it is the only business capable of producing and selling the good at an affordable price. _____________________ Terri’s Tropical Fish. c. _________ What is the profit maximizing price? b. a. Some monopolies have cozy relationships tacitly act like a monopoly.Problem MONO2 (0) A monopoly might own all of the resources used to make a good or have exclusive ownership of the resources. identify the source of the monopoly power. e. ____________ How much profit would be made by a price discriminating monopolist? d. What is the profit maximizing output? a. the largest outlet for tropical fish in the Midwest. Complete the table and graph the demand. d. the only licensed lawyer in a town of 500 people. and marginal cost curves. A liquor store that requires a license. patent. Assume that marginal cost is a constant $9. Postal Service. the Matterhorn. what output would be produced? c. marginal revenue. 18 . ______________ Larry Litiagator. _____________ The U. b. Econexamcram on the iTunes Store. In each case below. After you graph the data. A monopoly might have a license. _____________ Want more review? Checkout my iPod App. ___________________ A railroad that owns all of the tracks for 500 miles around a hub. _________ Problem MONO3 (3) Hornbuckle Carnival Rides has one ride. Econexamcram on the iTunes Store. and marginal cost curves. 19 . Buyer Alex Barry Cisero Donovan Edward Maximum Price $50 40 30 20 10 Apple’s cost of making the Shuffle includes $50 of fixed costs and a constant marginal cost of $10. marginal revenue. ____________ If Apple can price discriminate. __________ How much profit is made? c. ________ How much profit will be earned by the price discriminating monopolist? e. What is the profit maximizing output? a.Problem MONO4 (0) Each of the following brothers are willing to pay the maximum price shown in the table for an iPod Shuffle. how many Shuffles will Apple sell? d. Graph the five brothers’ demand. _______ Want more review? Checkout my iPod App. __________ What is the profit maximizing price? b. and MC curves. Econexamcram on the iTunes Store. and d. c.Problem MONO5 (3) Punky’s Pies sells ice cream pies in a monopolized market. MR. How many pies are produced at the profitmaximizing output? _____ c. b. Data for her market is contained in the table below: Complete the table and graph the Demand. If Punky’s Pies were a perfectly competitive market. P 20 18 16 14 12 10 8 6 4 2 Q TR MR TC MC ATC Profit 0 8 1 14 2 22 3 32 4 44 5 58 6 74 7 92 8 112 9 147 a. What would be the longrun price if the market were perfectly competitive?_____ Want more review? Checkout my iPod App. If Punky only cares about the maximum revenue she can earn. about how many pies would she make?______ d. how many pies will maximize her total revenue? __________ b. Answer questions a. 20 . the firm is easily identified by a broad sweeping ATC curve and low variable costs. and marginal cost assuming that marginal cost is a constant $1.00. __________ What is the price elasticity of demand between $3.Problem MONO6(0) The iMAX is the only theater in the tiny town of Maxwell. ____________ How much is consumer’s surplus at the profitmaximizing price? g. The low variable costs can be seen in the marginal cost curve which over this range of output is constant. Want more review? Checkout my iPod App. __________ Sample 4 – Natural Monopoly A natural monopoly is so big that it supplies the entire market.00 $4. If the citizens of Maxwell force the theater to sell at the perfectly competitive price.00 $3.00? e. a mining town in Rural Iowa. how many drinks will be sold? b.00 and $2. 21 . What will be the price of a drink at the iMax a.00 Quantity 0 10 20 30 40 50 60 70 Graph the demand.00 $0. marginal revenue. ________ How much is total cost at the profit-maximizing price? d. This market structure is characterized by high fixed costs that are spread out over a large range of output. Econexamcram on the iTunes Store.00 $5. ___________. The demand for popcorn once inside the theater is given in the following demand schedule: Price per Drink $7. ___________ How much is the dead weight loss when the iMax sells popcorn at the profit-maximizing price? f.00 $1. Because of the high fixed costs. _________ How much is total revenue at the profit-maximizing price? c.00 $2.00 $6. Shade the area dead weight loss. resource allocative output. _________ Solutions: Want more review? Checkout my iPod App. __________ If this firm were regulated at the socially optimal output. ________ d. What is the price at the profit maximizing output? a. Econexamcram on the iTunes Store.Problem MONO7 (0) In the problem below. what would be the price and output? b. 22 . answer the questions that follow: The firm still maximizes profit where MR = MC. that is. Price ________ Output_______ At the socially optimal output how much profit is the firm making? c. Should this municipality be subsidized or taxed? e. $4 – 4. $5 I.$7 – 3. $25 if you include the whole area of consumer’s surplus. $7 c.5 l. MONO3 a. 5 b.5 c. License b. 5 m. $4 b. 10. 6 b.5. $30 e. Legal right e. Pure Monopoly b. $21 e. 120 d. 3 d. License d. -1 d.56 f. $5. Elasticity Name __________________ 23 Want more review? Checkout my iPod App. . $12 f. $20 if you assume a stairstep and discrete quantity. Answers can vary. subsidized.67 MONO6 a. 4. not shown. 5 e. .5 c.5 J. 2. $100 MONO5 a.MONO1 a. 2. E. Econexamcram on the iTunes Store. 3. $5. 45 g. About 4 d. MONO4 a. 30 c.5 k.5 c. MONO2 a. Shade Triangle.5 MONO7 a. $30 c. 3 b. $1. $9 G. The monopolist has to lower the price to sell the next item. 5 d. $14 b. Possibly all. about 5. Below $5 H. Economies of Scale or Exclusive ownership of a resource c. 60 in profit d. 4. 00 for a profit of $300. he is charging $600 per hour and seeing 8 patients in 2 hours.00 per hour? The good doctor would increase his revenue to $1.200. If Dr. Kay lowers his price to $500. his profits are maxed by working two hours. What happens if Dr. He charges $150. His total revenue is $700.500.00 but his profit would fall to $200. Dr.00. Dr. Does this explain why doctors aren’t open on weekends and Fridays? A good is elastic in the range of demand when total revenue increases when the price decreases or total revenue falls when the price increases.00 per patient.00 for a profit of $400. He is thinking about raising his prices.00 and his total cost is $400. Kay raises his price to $700. D. D. What if Dr. Kay could see more patients and perhaps do more good by working four hours. He sees 4 patients per hour no matter what so he has a constant cost of $400 per hour. D Kay’s demand for his services is shown. D. Kay should not raise prices.00. Want more review? Checkout my iPod App. Kay should keep his price right where it is at $600. However. Kay wants to increase his revenue.Sample 1: Dr. Econexamcram on the iTunes Store.00. D. 24 .00 per hour? His total revenue FALLS and so does his profit. His total revenue is $1. Dr. Kay is at point A. D. Dr. In AP Microeconomics. “U” if the price is unit elastic. Salt is inelastic. Salt has few substitutes and is inexpensive. Econexamcram on the iTunes Store. the need for air conditioning is more elastic in winter where the temperatures are below zero than in summer when the temperatures are above 100 degrees. The need for medical attention for a patient who lops his hand off sawing wood. A caffeine addicts need for caffeine now. Want more review? Checkout my iPod App. A heart patient’s demand for Aortacin.Elas1 (0) Total Revenue Test In the table below. a. They are 1) Time 2) Percentage of Budget Spent on the Good 3) The Number of Substitutes for the Good. It is unlikely that consumers will change their demand for salt if salt increases in price. which factor of elasticity most probably describes the good’s elasticity. For example. Elas2 (0) Three Elements of Elasticity In the problems below. Plastic surgery for breast implants. Next. and “I” if the price is inelastic. _____________________ b. _____________________ d. three factors influence how elastic the response is to an increase in price. a medicine that keeps the heart beat rhythmic. compute the total revenue by multiplying price and quantity for each price and quantity. circle “E” if the price is elastic. _____________________ c. 25 . Sample 2. ____________________ e. The price of a 20¢ can of peas goes up a penny. ____________________ f. The opera La Boheme ticket prices sell for $100 each, but all tickets sell out to a wealthy clientele. ____________________ g. Cable television increases its service cost by a $1, and hundreds start renting DVDs. ____________________ h. Gas prices are driven up to $4 a gallon, and millions start carpooling to work. ____________________ Elas3 (3) Billy Soundoff claims that oil companies are a monopoly because he observes profits of big oil going up when the price of crude oil goes up. He claims that Big Oil can raise prices and therefore raise profits. Sketch a demand, marginal revenue, and marginal cost curve and use the concept of elasticity to show that a monopoly would never operate on the inelastic portion of the demand curve. Show that a monopoly only operates on the elastic portion and thus could not raise price without sacrificing profit. Sample 3 The Mid Point Formula Economists rely on observation to explain behavior. To quantify a consumer’s response to a price change, the College Board uses a mid point formula to determine is demand is elastic, unit elastic, or inelastic. If the price of Hungry Harry Porkchops raises fro $6 to $7 and the quantity falls from 20 to 10, the price elasticity of demand, PED equals 4 2/3. The chops are very elastic. If the price of Ugly Ducklings increases from $2 to $3 and the quantity demanded changes from 14 to 12, the PED equals .46. Ugly Ducklings are inelastic. Want more review? Checkout my iPod App, Econexamcram on the iTunes Store. 26 Elas4 (0) Use the midpoint formula to calculate the price elasticity of demand for points, AB, BC, CD, and DE. Calculate the price elasticity of demand at point A and E. Sample 4 Cross Elasticity Goods that are consumed together are complementary goods. Chicken and beef are substitutes. When the price of peanut butter goes up, people buy less peanut butter and less jelly. The demand for jelly decreases. A good is a complementary good when the cross elasticity of demand is negative. A good is a sub when the cross elasticity is positive. Sally always has cream in her coffee. When the price of coffee increased 10%, Sally decreased her consumption of cream by 5%. Coffee and cream are complements for Sally. Juan is a socialite. For Juan espresso is a substitute latte. When the price of espresso increases 8%, Juan’s demand for latte increases 10%. The general formula is given to the left. If the result of the change in demand for good A divided by the change in the price for good B is positive, the goods are subs. Otherwise, comp’s. Elas5 (0) Complete the table using the Xed formula above. Good A Shoes Qd -8% Pens Qd +10% Corn Qd +12% Books $P +3% Good B Socks $P +6% Pencils $P +12% Soybeans $P +16% Kindle Qd +9% Xed Sub? Comp? Want more review? Checkout my iPod App, Econexamcram on the iTunes Store. 27 Review: The total revenue test. It’s easy to know if a good is elastic. Simple find total revenue at a price and quantity then raise the price. Calculate total revenue again. If total revenue falls, the price is elastic in that range. Sample 5 Income Elasticity When your income goes up, do you buy more or less of a good, say, hotdogs? If you buy more, the good is a normal good. If you buy less, the good is an inferior good. Juan’s boss just gave him a $1 and hour raise. As a result of this wage increase, Juan’s income goes up. Juan buys more downloads from the iTunes store. For Juan, downloads are a normal good. If, for example, Juan’s income increased 10% and his downloads increased 3%, Juan’s income elasticity is +.3 = 3%/10%. Since the result of this ratio is positive. Downloads are a normal good. If the good is inferior, than quantity demanded, Qd, will be negative. A negative income elasticity indicates that the good is inferior. A positive income elasticity indicates that the good is normal. Elas6 (0) Income +Y 3% +Y 6% -Y 20% +Y 50% -Y 35% Qd -10% Head Cheese +5% Breakfast Bars +12% Marconi +64% Diamonds +40% Ramen Noodles Yed Normal? Inferior? Want more review? Checkout my iPod App, Econexamcram on the iTunes Store. 28 a. 29 . _______ Elas8 (1) Explain why a Snickers Bar has more subs. than candy bars.Sample 6 Elasticity of Supply Supply can be elastic. Want more review? Checkout my iPod App. _______ b. Elas7 (0) In the graph below. Elas9 (0) Draw a perfectly inelastic supply curve in red and a perfectly elastic supply curve in blue below. Price Elasticity of Supply AC. QS. You might have guessed that the formula is: Suppose that red roses at Valentine’s Day increasing by 5% and the quantity supplied. unit elastic. perfectly inelastic or perfectly elastic. increases by 10%. and therefore more elastic. calculate the price elasticity of supply from point A to B and A to C. Roses are elastic in this range. Price Elasticity of Supply AB. Econexamcram on the iTunes Store. inelastic. c. 30 . a. Econexamcram on the iTunes Store. Want more review? Checkout my iPod App. b.Elas10 (0) List at least factors that influence the elasticity of supply. Elas4 AB 7 BC 1. Subs. f. subs. time b. Econexamcram on the iTunes Store. c. Elas3 The monopolist produces where MR=MC which always results in a price on the elastic portion of the curve.67 CD 1. d time e. % of budget g and h subs.Solutions Elas1 Elas2 a. 31 .67 DE 1/7 Elas5 (Table) Good A Shoes Qd -8% Pens Qd +10% Corn Qd +12% Books $P +3% Good B Xed Sub? Comp? -8/6 Comp Socks $P +6% +10/+12 Sub Pencils $P +12% Soybeans +12/+12 Sub $P +16% Kindle +3/+9 Sub Qd +9% Want more review? Checkout my iPod App. Stocks of resources in the production process Elas10 The three factors influencing the elasticity of supply are: the price of the product from which the inputs are derived. Reeses Peanutbutter Cup. Want more review? Checkout my iPod App.55__ b. the amount of time involving in changing supply. Econexamcram on the iTunes Store.3 Inferior +Y 6% +5% Breakfast Bars . Time to change plant or facility b. Ease of factor substitution e.Elas6 Normal? Inferior? +Y 3% -10% Head Cheese -3. 32 . Excess capacity d. For example. _1.6 Inferior +Y 50% +64% Diamonds 1.14 Inferior Elas7 Income Qd Yed a. Price Elasticity of Supply AB. Price Elasticity of Supply AC. and the price of complementary inputs.11_ Elas8 There are more subs for a specific candy bar like Snickers. you could sub a Baby Ruth.83 Normal -Y 20% +12% Macrooni . or Milky Way for a Snickers.28 Normal -Y 35% +40% Ramen Noodles -1. _. Time to get resources c. There are no subs for candy bars. What would be a reasonable sub for the broad category “Candy Bars”? Elas9 Elas10 a. Econexamcram on the iTunes Store. is found by taking the slope of the Total Product curve. AP is rising. The table shows the calculations. it’s important to know that total product increases at a decreasing rate. AP. Can you give an intuitive reason why the two curves must intersect at the maximum AP curve? Economists like to talk about the Average Margin Rule to describe this relationship. less is produced. For the AP Exam.Production Costs Sample 1 Production Function Name _________________________ The firm’s production function shows how output is related to labor inputs. As more labor is added to a fixed resource such as a machine. is found by dividing Total Product by the quantity of labor. Because diminishing marginal returns set in after the second worker. 33 . Average Product. This is important because labor is expensive. MP. Want more review? Checkout my iPod App. When MP is above AP. the marginal product pulls the AP curve down. If you equate AP to your GPA. When MP is below AP. then you know higher grades in your classes rise your GPA and lower grades lower your GPA. Costs rise exponentially. Sample 2 Marginal and Average Products Marginal Product. AP is falling. The MP curve intersects the AP curve when AP is at the maximum. After two units of labor are employed. Econexamcram on the iTunes Store. Sample 3 – Returns to Scale Using two labor resources results in increasing returns to scale.Costs1 (0) Use the data contained in the graph for Sample 1 to construct the MP and AP curves. diminishing marginal returns set in. Draw the MP is red and AP in brown. Costs2 (0) Use the data contained in the graph for Sample 2 to construct the Total Product curve. The fifth worker adds negative returns. Want more review? Checkout my iPod App. 34 . and ATC The table data has been plotted on the graph to the left. marginal cost is at the lowest point as the table shows. Sample 4 – Cost Curves How are the total product curve and marginal product curve related? When marginal product is at its peak. 35 . Labor TP FC 0 0 10 1 3 10 VC TC 0 10 5 15 15 20 25 30 25 30 35 40 MC 1. show increasing returns to scale and decreasing returns to scale. Econexamcram on the iTunes Store. Want more review? Checkout my iPod App.6 MP 3 2 3 4 5 6 9 10 10 20 .25 1. AVC.834 6 1 1.5 5 4 3 2 14 18 21 23 10 10 10 10 Sample 5 – AFC. The rapidly decreasing slope is due to spreading of fixed costs over a range of output.Costs3 (0) On the graphs for Costs1 and Costs2.6 2. Average Variable and Average Total Costs Costs4 (0) Complete the table below. Econexamcram on the iTunes Store. Labor TP MP AP FC VC TC AFC AVC ATC 0 1 2 3 4 5 6 7 0 6 14 24 32 38 42 44 8 8 8 8 8 8 8 8 0 5 10 15 20 25 30 35 Want more review? Checkout my iPod App. 36 . Costs5 (0) Use the data from Costs4 to graph AVC and ATC. Want more review? Checkout my iPod App. 37 . Econexamcram on the iTunes Store. 18 .33 . For some workers the capital might hinder their output while others can create a monument.71 . diminishing returns set in immediately.977 Want more review? Checkout my iPod App.19 .83 .33 . Costs3 (0) On both graphs. 38 . Costs2 (0) It’s important to note that the curve increases at a decreasing rate.6 8 25 33 7 8 30 38 6.65 .Solutions Costs1(0) Although the solution does not resemble the example. Diminishing marginal returns are pulling the average product curve down just as the theory predicts. MP and AP intersect at the apex.71 . Of interest to me is how labor combines with capital to produce output.86 .2 8 35 43 AFC AVC ATC 1. Econexamcram on the iTunes Store.875 .57 .21 .795 2.25 .17 1.28 .62 .90 .95 .625 . Costs4 (0) Labor TP MP AP 0 1 2 3 4 5 6 7 0 6 14 24 32 38 42 44 6 8 10 12 6 4 2 FC VC TC 8 0 8 6 8 5 13 7 8 10 18 8 8 15 23 8 8 20 28 7. 5 2 Costs 1.5 0 0 2 4 Quantity 6 8 AVC ATC Want more review? Checkout my iPod App. Econexamcram on the iTunes Store.5 1 0. 39 .Costs5 (0) AVC and ATC 2. flu shots. Economists recommend placing a Pigouvian Tax on the sale of meth. but the quantity increases from 4 to 5. the government can give energy credits or tax breaks that effectively lowers the cost. noise. Want more review? Checkout my iPod App. and education. Furthermore. drug enforcement incarcerates Michael and the state suffers from the burden of rehabilitation and social medicine. crystal meth is over produced and represents a negative externality. Sample 2 – Negative Externality Michael is a crystal meth addict who has to steal to support his habit. Therefore. Ralph Rider gets tremendous pleasure from his neighbor’s work but he incurs none of the cost. Since the cost is artificially lowered the MSC does not shift.Externalities and Market Failure Sample 1 – Positive Externalities Name ______________________ Wanda and Willy like to make their house look like a winter wonderland during winter. Michael’s addiction has “spill over” costs that are imposed on family members. The socially optimal output is arrived at when MSB=MSC. Since the distribution of meth is illegal. Economists say that Wanda and Willy’s displays “spillover” to Ralph. Now less is demanded. in the case of a positive externality. Classic negative externalities are: pollution. the good is “under produced”. The MSB curve shifts to the right to restore equilibrium at point 2. This corrective tax will shift the supply of meth to the left from point 1 to point 2 and increase the price. Classic positive externalities include smoke alarms. Perhaps the credits are $2. Econexamcram on the iTunes Store. From society’s standpoint. 40 . They decorate their home with tasteful lights and reefs. law enforcement officials. To induce Wanda and Willy and other neighbors to put up more lights and reefs. and flu. and social services. society would benefit from more winter lights and reefs. say $3. perhaps the tax comes in the form of a longer prison sentence or more community service. If there are many more neighbors like Ralph. Many citizens in Sally’s city wish that she could do more clean up especially along the river. Is the situation described a positive or negative externality? _________ Want more review? Checkout my iPod App. If there are hundreds like Tim and they lobby to tax big trucks. ____ 2.Extern1 (0) Answer each question “True” or “False”. When MSB is greater than MPB a negative externality exists. huge pick up trucks pull up along side of him and he can’t see on coming traffic. this generates an externality. A Pigouvian Tax corrects a positive externality. a. When he drives up to a dangerous intersection. The socially optimal output occurs where MSC = MSB. a. A negative externality has MSC > MPC. ____ 4. ____ 3. For Tim. What are some of the spill over externalities that the city might experience? ______________ Extern3 (0) Tiny Tim drives a compact car he calls the “bug”. Econexamcram on the iTunes Store. ____ 1. 41 . A positive externality is over produced. Should the city subsidize or tax this externality to achieve the socially optimal output? ________ c. ____ 5. Use the graph below to show the socially optimal equilibrium if Sally is given an incentive of $3 per hour of cleanup. Is this a positive or negative externality? ____ b. Extern2 (0) Sally Greene has organized a girl group to clean up the city. show the new equilibrium on the graph below if the city levies a tax of $3 per unit. ____ 1. A classic adverse selection case is when someone buys life insurance after they are diagnosed with a life threatening illness. Mike does not work to prepare lessons after he earns tenure at Dukes of Hazard Community College. Juan puts sells his car when Maheep offers him more than the car is worth even though the car has a bad ignition. Paris and Astro get married with the idea that they can easily divorce if they want to. Econexamcram on the iTunes Store. Free riders benefit when the good consumed is nonexcludable like national security. place “MH” if the event describes a moral hazard and “AS” if the event describes adverse selection. ___10. ____7. Banks make many sub-prime loans because the FDIC guarantees payment to bank in the event of default. Extern4 (0) In each case below. Mary does what she wants to do at work because her father is the owner. ISU’s pet agricultural project on Ethanol is funded even if it is a failure. A moral hazard happens after perverse incentives are misaligned. Sample 4 – Free Rider A free rider is someone who gets all of the benefits without any of the cost. ____5. Every student in Professor Hurt’s class gets at least a B in the class. The difference between the two is in the time. Adverse selection happens before another event. ____6. In both cases the risk and costs have been shifted to another party who has asymmetrical information. applies to work at Barry’s Bar and Grill since they don’t drug test. ____4. 42 . Scott. ____3. ____9. a heavy meth user. A classic moral hazard is the seat belt law which prompted drivers to drive faster. Because condoms are distributed free at school. ___11. Larry engages in more sex than he would otherwise. Jim gets a credit card offer in the mail and immediately activates the card even though he’s deeply in debt. ____8. Pete is always broke and keeps spending knowing that his mom will bail him out with a loan. Iowa has a no-fault divorce law.Sample 3 – Moral Hazard and Adverse Selection A moral hazard occurs when one party can shift the cost of their actions onto another. Want more review? Checkout my iPod App. Kathy is in Professor Hurt’s class and never studies. ____2. 43 . Label all curves. Econexamcram on the iTunes Store. sketch the market for gasoline. Extern6 (0) On the graph below. Explain in 50 words or less if you agree or disagree with Harry. Assume that exhaust exerts a cost on third-party individuals who are neither buyers nor sellers of gasoline.Extern5 (0) Harry claims that if there were no government no private individual would have the incentive or the means to provide public education and national defense. Want more review? Checkout my iPod App. Solutions Extern1 1. There would be free riders if someone provided the good itself. Econexamcram on the iTunes Store. T 2. equilibrium price is $5 and quantity is 7 Extern3 $4. Want more review? Checkout my iPod App. negative Extern4 2. Cleaner and healthier town. F 5. Subsidize. There’s no incentive to produce when all of the benefits accrue to free riders. T Extern2 Positive. Extern5 Agree. 8 and 9 are adverse selection. 44 . The rest are moral hazard. F 3. F 4. Extern6 Anything that looks like Sample 2. we subtract from CINP those who have given up looking for work or discouraged workers. Louis Federal Reserve Bank. Econexamcram on the iTunes Store. Basic1 (0) The data below is from the FRED data base hosted at the St. The labor force is composed of the unemployed plus the employed. and child. This is the Civilian NonInstitutionalized Population. Finally. This data can be directly obtained at: http://research.stlouisfed. The employment rate is found by dividing the number of employed by the labor force by the Civilian Non-Institutional Population. 45 . Now we subtract those in the military. the Labor Force Participation Rate is found by dividing the Labor Force by the Civilian NonInstitutional Population. Unemployment Employment Labor Force Year Rate Rate Participation Rate 2005 2006 2007 2008 2009 2010 Basic2 (0) Want more review? Checkout my iPod App. That is every man. Next. The unemployment rate is found by dividing the number of unemployed by the labor force. We have now derived the Civilian Labor Force. LF. and those under the age of 16. retired. All data is in thousands. and the labor force participation rate.org/fred2/categories/12. employment rate. The series ID is at the top of each header.Basic Concepts MACRO Sample 1 – Unemployment Rate Name _______________________ Let’s begin with the population. CNP160V CINP 224837 227553 230650 232616 234739 236832 CIF160V LF 148029 150201 153117 154048 154140 153170 CE160V Employment 140245 143142 146032 146421 142221 138333 UNEMPLOY Unemployment 7784 7059 7085 7628 11919 14837 Year 2005 2006 2007 2008 2009 2010 For each year in the table above compute the unemployment rate. woman. (000). In what year was the economy operating at its natural rate of unemployment? _____ Sample 2 – Inflation Rate The inflation rate is simply the change in the Consumer Price Index. Louis Federal Reserve Bank. if the CPI this year is 112 and the CPI last year was 110.8%. Specifically.96 217.6 Basic4 (0) Want more review? Checkout my iPod App. Year 2005 2006 2007 2008 2009 2010 CPI Inflation Rate 191. 46 . The data series is found at http://research.6 199.2 203. the inflation rate is 1. the Consumer Price Index All Urban Consumers All Items. A recession often is accompanied by high unemployment. CPI.Graph the unemployment rate below using your calculation for Basic1. In what year. from year to year. A healthy inflation rate is 2%.org/fred2/graph/?id=CPIAUCSL. For example. the series is CPIAUCSL. Complete the table by calculating the inflation rate. Basic3 (0) The data below is from the FRED data base hosted at the St.4 212.23 211.stlouisfed. Econexamcram on the iTunes Store. would you opine the recession began? _______ The natural rate of unemployment is 5%. 7%. 2008. KWBOOHOO in Ames.7%. When the unemployment rate was 9. Calculate the rate of change in sad songs. Does Carls Badd theory hold true? Year 2005 2006 2007 2008 2009 2010 Sad Songs Change in Sad Songs 832 800 784 800 840 889 Sample 3 Changing the base Want more review? Checkout my iPod App. Use the graph below. and 2010. In periods of high unemployment. what do you predict the inflation rate to be. what was the inflation rate? ___________ d. He swears that there’s a relationship between the number of sad love ballads and the state of the economy. Iowa. When the economy was at its natural rate.Graph the inflation rate you calculated in Basic3. When the unemployment was 4. 2009. a. (high or low)? ___________ Basic5 (0) Carls Badd loves country and western music. For the years 2005. what was the inflation rate? __________ b. 2007. 47 . The table below has his results. Econexamcram on the iTunes Store. what was the inflation rate? _________ c. 2006. Carls has kept track of the sad songs played on his favorite station. in year 2. Real GDP (AP Way) is found by dividing nominal GDP by the price index. See if you can discover how the data interacts with each other to construct a picture of the economy. Assume that a cheeseburger is the only good made. Repeat for year 1. Real GDP can be calculated by taking current year output at base year prices or dividing nominal GDP by a price index. Next divide.2 ($12/$10). 120 by 120 and multiply by 100. divide 140 by 120 and multiply. Does the selection of the base year make a difference in the inflation rate? ________ Sample 4 -. The GDP Deflator is found by dividing nominal GDP by real GDP. 48 .2 1. Year Price Quantity NGDP RGDP GDP Deflator 1 2 3 4 5 $10 $12 $14 $13 $14 5 6 8 7 9 $50 $72 $112 $50 $60 $80 1 1. The new index is: Year 1 2 3 4 5 CPI 83 91 100 108 117 Basic6 (0) Calculate the inflation rate from year 1 to 5 in each table above. To find year index. In year 1.Suppose that the CPI for 5 years for the country of Omega is contained in the table below. the price index equals 1 ($50/$50).Deflator in Action The table below combines many basic concepts.4 RGDP (AP Way) $50 $60 $80 Basic7 (0) Want more review? Checkout my iPod App. divide 120/120 and multiply by 100. divide 110 by 120 and multiply by 100. Econexamcram on the iTunes Store. Year 1 2 3 4 5 CPI 100 110 120 130 140 To make year 3 the base year. the price index equals 1. then the real interest rate is 3%. Basic8 (0) Using the same data as Sample 4. change the base year to year 3. Calculate the real GDP for each year. Year Price Quantity NGDP RGDP GDP Deflator 1 2 3 4 5 $10 $12 $14 $13 $14 5 6 8 7 9 RGDP (AP Way) Basic9 (1) The data below is from the FRED data base hosted at the St. If the nominal interest rate is 10% and the expected rate of inflation is 7%. Basic10 (0) Complete the table below using Sample 5 as an example. Recalculate the table. Want more review? Checkout my iPod App. 49 . Econexamcram on the iTunes Store.Complete the table in Sample 4 for years 4 and 5. (NGDP figures are in billions.) (GDPDEF) GDP Deflator 88 89 91 91 93 95 98 102 105 (GDPA) NGDP 10286 10642 11142 11868 12638 13398 14078 14441 14256 Year Real GDP 2001 2002 2003 2004 2005 2006 2007 2008 2009 Sample 5 – Real Interest Rates The real interest rate is computed by taking the nominal interest rate minus the expected rate of inflation. Louis Federal Reserve Bank. Complete the table with the new quantities. Want more review? Checkout my iPod App. In the space below. Microeconomics predicts that a higher price of a good. Some economists assert that the CPI does not take into account the substitution effect and overstates the CPI. r Nominal Interest Rate. πe 2 4 2 The table below has had the quantities changed. changes the CPI. How does the GDP Deflator. explain what those economists mean when they say the CPI is overstated. 50 . say cheeseburgers. i 8 5 10 3 3 Basic 11 (0) Expected Rate of Inflation. Econexamcram on the iTunes Store. nominal GDP.Real Interest Rate. will lead to a substitution of a cheaper product such as soybean burgers. and real GDP change? Year Price Quantity NGDP RGDP GDP Deflator 1 2 3 4 5 $10 $12 $14 $13 $14 8 5 7 9 10 RGDP (AP Way) Basic 12 (0) The CPI assumes that the quantities do not change from period to period. The intent of this exercise is show how assumptions made as to the typical quantities consumed by the average consumer. Basic 13 (3) You are given the following data.2 5 6. Econexamcram on the iTunes Store. Calculate the CPI for Year 1.1 5 6. and 3. 51 . 2. Year 1 $P Q Expenditure 3 8 6 20 Item Year 2 Year 3 $P Expenditure $P Expenditure 3.5 3.5 4.5 A B C 5 Totals Index 6 Want more review? Checkout my iPod App.7 5 4. 25% 62.3% 66% 4.4% 64% Basic 2 Year 2005 2006 2007 2008 2009 2010 Basic 3 Year 2005 2006 2007 2008 2009 2010 CPI 191.9% 2.1% 4.2 203. 52 .62% 63.3% 65% 4.1% 60.5% 65% 9.95% 63.6% 58. Econexamcram on the iTunes Store.8% Want more review? Checkout my iPod App.3% 66% 5.6 199.9% 66% 4.6 Inflation Rate --------------3.Solutions Basic1 Unemployment Employment Labor Force Rate Rate Participation Rate 5.96 217.3% 0% 2.69% 62.23 211.4 212. 8% Sad songs seem to be related to the state of the economy.Basic 4 Inflation Rate 5. Data weakly confirms this.4 RGDP (AP Way) $50 $60 $80 $70 $90 Want more review? Checkout my iPod App.00% 4. The choice of base doesn’t change the inflation rate but changes the index.00% Inflation Rate a. 53 .5% D.8% -2% 2% 5% 5. Basic 7 Year Price Quantity NGDP RGDP GDP Deflator 1 2 3 4 5 $10 $12 $14 $13 $14 5 6 8 7 9 $50 $72 $112 $91 $126 $50 $60 $80 $70 $90 1 1.3 1.00% 2005 -1. Basic 6 The inflation rate is still 40%.6% c. 9. Inverse relationship between unemployment and inflation. 7. 2006 2007 2008 Year 2009 2010 2011 Basic 5 Year 2005 2006 2007 2008 2009 2010 Sad Songs 832 800 784 800 840 889 Change in Sad Songs -3. 2009 b.00% 1.4 1.00% 0.00% 2.2 1. Econexamcram on the iTunes Store.00% Inflation Rate 3. r 6 5 3 1 Basic 11 Year Price Quantity NGDP RGDP GDP Deflator 1 2 3 4 5 $10 $12 $14 $13 $14 8 5 7 9 10 $80 $60 $98 $117 $140 $80 $50 $70 $90 $100 100 120 140 130 140 RGDP (AP Way) (GDPA) NGDP (billions) 10286 10642 11142 11868 12638 13398 14078 14441 14256 Year Real GDP 2001 2002 2003 2004 2005 2006 2007 2008 2009 11688 11957 12243 13041 13589 14103 14365 14157 13577 Nominal Interest Rate.4 85 100 92 100 RGDP (AP Way) $70 $84 $112 $98 $126 Basic 9 (GDPDEF) GDP Deflator 88 89 91 91 93 95 98 102 105 Basic 10 Real Interest Rate. i 8 10 7 3 Expected Rate of Inflation. πe 2 5 4 2 $80 $50 $70 $90 $100 Want more review? Checkout my iPod App. 54 .Basic 8 Year Price Quantity NGDP RGDP GDP Deflator 1 2 3 4 5 $10 $12 $14 $13 $14 5 6 8 7 9 $50 $72 $112 $91 $126 $70 $84 $112 $98 $126 71. Econexamcram on the iTunes Store. 2 A 3 8 24 3.2 B C 6 20 120 5 6.Basic 12 Economists mean that the CPI reports that inflation is higher than it actually is.5 135 27 187.7 5 4. Econexamcram on the iTunes Store. Since consumers will buyer the cheaper product. Basic 13 Item Year 1 Year 2 Year 3 $P Expenditure $P Expenditure $P Q Expenditure 26 3.5 130 27 183 105 5 6 Totals Index 30 4. inflation doesn’t hurt the consumer as much as the index suggests.5 174 100 5 6.2 108 Want more review? Checkout my iPod App. 55 .1 25. $15. and divide by the price level and multiply by 100. Notice that this is a movement along the curve since the only variable that is changing is the price level. the consumer buys a fixed market basket and save the rest.000. Want more review? Checkout my iPod App. So when the price level falls. For the macro economy. suppose that Harriet has $5. and $10. What is the inflation rate? _________ Sample 2 – Interest Rate Effect What is not spent is saved. Compute Harriet’s real balances for each price level in the table below.500. Price Level Real Balance 80 90 100 110 AD2(0) Suppose the price level changes from 123 to 125. and Android). your savings becomes worth more and your buying power is boosted. As the price level falls. Harriet’s buying power increases causing her quantity demanded to increase from Q1 to Q2. The quantity demanded of real GDP increases. computer. her buying power decreases and the quantity demanded falls.Aggregate Demand/Supply Sample 1—Real Balances Name _____________________________ One reason why aggregate demand slopes downward and to the right is the Real Balances Effect. the real balances effect can be illustrated as shown. Econexamcram on the iTunes Store. When the price level declines. What is the value of her real balances when the price level is 120? Simply add her assets together. 56 . The lower interest rates induce more business investment and household consumption of durable goods. The supply of savings increases and interest rates fall. The value of her assets when the price level is 120 is $12.000. When the price level increases. The value of her real balances when the price level is 100 is $15. To interpret.000 in non monetary assets (car. AD1 (0) Assume that Harriet has $15.000 in cash and assets.000 in cash. Want more review? Checkout my iPod App. It’s like buying at Walmart* a pair of shoes for $10 instead of buying the shoes at Shoe Carnival for $20. they will pay back $8. Econexamcram on the iTunes Store. This means that for every $100 dollars a consumer or business borrows. So Alpha citizens buy less domestic goods and the quantity demanded decreases. AD3 (0) How much interest would HNI have to repay if they wanted to borrow $10 million and the interest rate was 4%? _____________ Sample 3 – Foreign Purchases Effect When the price level is higher in Alpha than the price level in Beta. the price level for Alpha increases from A to B. If the price level drops to 100 and consumers save more. it’s cheaper for Alpha consumers to buy from Beta. This interest rate effect also works in reverse.000 in interest. HNI will only pay $600.000. Alpha and Beta consumers find it cheaper to buy from Beta so the quantity demanded falls from Q3 to Q2. they will pay in interest $800. 57 .Suppose that when the price level is 120 the interest rate is 8% . In the example. If HNI borrows $10 million to finance capital restructuring. Want more review? Checkout my iPod App. the economy moves along the aggregate demand curve for three reasons. But the AD curve can shift because of exogenous variables. or stock market assets were increasing. the AD will shift to the right to point D. Sample 4 – Aggregate Demand Shifts When the price level changes. So any change in C. I.AD4 (0) Explain how the foreign purchases effect would work if the price level in Alpha decreased. Suppose the economy is at point B. Econexamcram on the iTunes Store. The same shift would have happened if personal income taxes were reduced. A change in personal taxes and expectations of future prices will shift the curve. consumers felt that prices were going to be higher in the future. When people feel wealthier. business increase their investment. G. Anything that changes spending shifts the AD curve. or the government increases its spending. or Nx shifts the curve. One example will explain. If the USD were depreciating. the AD would shift from AD to AD1. they spend more. If consumers spend more. 58 . the quantity of aggregate demand changes as the price level changes. AD shifts. In other words. So if the value of their assets or their income changes. goods suddenly become attractive to foreigners Businesses become optimistic about future sales Foreign income increases Business taxes increases. 7. 12. 14. S. 11. 59 . 9. 17. 5. 4. 13. Econexamcram on the iTunes Store. Want more review? Checkout my iPod App. 15. Businesses expect lower profits Consumer spending on durables declines USD appreciates relative to foreign currencies Personal income taxes decline Wealth increases because of higher stock market values AD (U or D) Real GDP (U or D) 1. 8. 18. 10. Investment increases U. Domestic exports increase The money supply increases along with consumption The government pursues contractionary Fiscal Policy A lower reserve ratio spurs more lending to business. 3. 6.AD5 (0) Event PL (U or D) Personal income taxes decrease Consumer confidence spurs increased spending Housing values skyrockets Businesses become pessimistic about the future The USD rapidly appreciates because of higher domestic interest rates Government slashes military spending iPods become the rage around the world. 16. 2. 11. Econexamcram on the iTunes Store. 12. goods suddenly become attractive to foreigners Businesses become optimistic about future sales Foreign income increases Business taxes increases. AD would shift to the right. 4. 10. Up Down Up Up Down Up Up Up Up Down U Right D Left U Right U Right D Left U Right U Right U Right U Right D Left Up Down Up Up Down Up Up Up Up Down Want more review? Checkout my iPod App. 8. 13. 14. 5. 3. 2. Event Personal income taxes decrease Consumer confidence spurs increased spending Housing values skyrockets Businesses become pessimistic about the future The USD rapidly appreciates because of higher domestic interest rates Government slashes military spending iPods become the rage around the world. Investment increases U. Businesses PL (U or D) Up Up Up AD (U or D) Real GDP (U or D) U Right Up U Right Up U Right Up Real Balance 18750 16666.62% AD3 The interest is: $400.Solutions AD1 Price Level 80 90 100 110 AD2 The inflation rate is 1. 60 . Net exports would increase.37 1. Domestic exports increase The money supply increases along with consumption The government pursues contractionary Fiscal Policy A lower reserve ratio spurs more lending to business. 6.67 15000 13636. 9. S.000 AD4 The USD would appreciate as more US goods would be demanded by foreigners. 7. 18. 61 . expect lower profits Consumer spending on durables declines USD appreciates relative to foreign currencies Personal income taxes decline Wealth increases because of higher stock market values Down Up Up Up D Left U Right U Right U Right Down Up Up Up Want more review? Checkout my iPod App. Econexamcram on the iTunes Store.15. 16. 17. Yet. Worker misperceptions are another reason the aggregate supply curve slopes upward. Say that Harry gets a 2% wage increase. Suppose Juan signs a contract to roof houses at $100. Economists refer to “sticky” prices to describe the restaurant’s response. During the time Juan signs the contract to the duration. his wages are “sticky” as he’s unable to renegotiate a higher wage in response to a higher price level. but the inflation rate is 5%. A flat AS curve infers that prices are sticky and inflexible downward. some producers make more because they underestimate the inflation rate. Still. The AS curve slopes upward and to the right because of sticky wages and sticky prices.000 a year. Producer misperceptions are another reason why the aggregate supply curve slopes upward. some restaurants can change their prices. Since resources are idle. changes in the price level leave the employee sometimes better off and sometimes worse. However. Sellers routinely believe that they have marked up prices to keep up with inflation. Sticky prices are a reason why the aggregate supply curve slopes upward. Sticky wages are a reason why the aggregate supply curve slopes upward. Harry’s real wage is 3% lower. Workers often mistake a raise in their nominal wages with a raise in their real wage rate. Likewise. but because he misperceives his wage increase as a increase in his real earnings.Aggregate Supply Sample 1 – Slope of AS Curve Name ______________________ When employees enter into long-term contracts that last for years. Since Juan has signed a contract. I interpret the horizontal AS curve to mean that there are many idle resources. as the price level increases. Both sticky prices and sticky wages are often used to describe the slope of the aggregate supply curve.667 to $57. The producer produces more as she thinks that she’s keeping up with inflation. one can interpret the flat AS curve to mean that in the short run firms simply Want more review? Checkout my iPod App. Sample 2 -. Juan’s real earning power declines from $66. restaurant owners who print expensive menus cannot change their prices in response to rising prices because of the cost of reprinting menus. 62 . the price level rises fro 150 to 175.A Horizontal Aggregate Supply Curve One interpretation of price rigidity is that the AS curve is flat. but economists generally agree that the producer has underestimated the inflation rate. some roofers who do not have contracts can raise their prices so that their earnings keep up with inflation.143. Econexamcram on the iTunes Store. Thus. Harry works more. they come into production at little opportunity cost so the price of these resources do not increase. an increase in wages paid to labor will shift the AS curve to the left. For example. If labor becomes more productive. A positive supply shock might be the technology of the Internet. In the graph. AS shifts to the right when resources become cheaper. 63 . an adverse supply shock comes from a rise in oil. Want more review? Checkout my iPod App. Econexamcram on the iTunes Store.meet demand because they are unsure if the demand increase reflects consumer preferences for their product or a rise in the price levels. cost of resources. In AP Macroeconomics. and supply shocks can shift the curve. AS1 (0) List the reasons why the AS curve slopes upward and to the right. Changes in technology. AS2 (0) On the graph. Explain why each reason contributes to the slope. the AS curve will shift to the right. Sample 3 AS Shifts The AS curve captures the relationship between the price level and real GDP. or there is a positive supply shock. or a new technology improves productivity of labor. show a beneficial supply shock. AS4 (0) On the graph. and employment in each case. show an increase in the price level. real GDP. Price Level a 112 b 116 c 125 Nominal Wage Real Wage $10 $10 $10 Want more review? Checkout my iPod App. 64 . show the effects of a decrease in wage rates. Econexamcram on the iTunes Store. AS5 (0) In the short run. what is the impact on the price level.AS3 (0) On the graph. Event PL RGDP UnRate Wages decrease Marginal Product of Labor Increases Oil price rise dramatically A decline in productivity Positive supply shock Non labor inputs increase A B C D E F AS6 (0) Calculate Juan’s real wage rate at each of the price levels in the table. Assume an upward sloping AS curve. Econexamcram on the iTunes Store.Solutions AS1 See Samples AS2 A new AS curve should be drawn to the right of the original AS3 A new AS curve should be drawn to the right of the original AS 4 The students should show a movement along the curve AS5 Event Wages decrease Marginal Product of Labor Increases Oil price rise dramatically A decline in productivity Positive supply shock Non labor inputs increase PL Down Down Up Up Down Up RGDP Up Up Down Down Up Down UnRate Down Down Up Up Down Up A B C D E F AS6 Price Level a 112 b 116 c 125 Nominal Wage $10 $10 $10 Real Wage $8.93 $8.00 Want more review? Checkout my iPod App.62 $8. 65 . At growth rates greater than 3.5%. This graph shows that when approximately 6. unemployment is increasing. series UNRATE and GDP1). Using the FRED data base. In Macroeconomics. At a natural growth rate of 3. real GDP was $12.5%. when the labor market is in equilibrium. The graph below shows the change in the unemployment rate and the GDP growth (%) from 1990 to 2010. When GDP is changing at 3. then the economy is in longrun equilibrium. If the economy was growing at less than 3.000 billion in 2005-2006. the economy is growing at about 3. unemployment is decreasing. then the labor market should be in equilibrium since labor is used to make GDP. Econexamcram on the iTunes Store. 66 .5%. the body is at rest or in equilibrium.Long Run Supply Macro Sample 1 – Theory Name ___________________________ There’s a tendency for a body to come to a rest. graphed this relationship. (FRED series UNRATE and GDP1 annual data. GDP is growing at the natural rate. When the economy is at a growth rate greater of less than 3.2% of the labor force is actively seeking employment. nothing is changing. Want more review? Checkout my iPod App. the economy must not be at the natural rate of unemployment.5%. When nothing is changing.) Notice that when the unemployment rate is zero.5%. Sample 2 – The Natural Rate of Employment A body is in equilibrium when it is at rest.5%. Currently. the porridge is too cold. the natural rate of unemployment is 5%. In Alpha. This vertical line captures the essence of a body at rest and a reference point. or equal to (Circle one) the natural GDP growth rate. Want more review? Checkout my iPod App. Show this adjustment on the graph below.Sample 3 – Long Run Supply In macroeconomics. the unemployment rate is 7%. LRS3 (0) In classical economics. greater than. the long run supply is 7 billion. and in the long run. the porridge is just right. inflationary gap. long run supply is shown as a vertical line at the natural growth rate of GDP. 67 . AD intersects SRAS at 5 billion in real GDP. In Alpha GDP growth is less than. wages and prices adjust to bring the economy into long-run equilibrium. in an inflationary gap. the labor market must be adjusting. LRS1 (0) In Alpha. Econexamcram on the iTunes Store. If short-run equilibrium is anywhere but on this line. or in long run equilibrium (circle one). Think of the long run like Goldilocks and the three bears. LRS2 (0) In Alpha. Is Alpha’s economy in a recessionary gap. the porridge is too hot. In a recessionary gap. Want more review? Checkout my iPod App. 68 . Econexamcram on the iTunes Store. AS5 (0) Use Fiscal Policy to move the economy into long run in each case below. wages and prices adjust to bring the economy into long-run equilibrium.LR4 (0) In classical economics. Show this adjustment on the graph below. show the new long run equilibrium on the graph. Using the graphs below.LR6 (0) In the graph below. LR8 (0) When the quantity of factors of production used to create goods increases. LR7 (0) In the graph below. Is the unemployment rate above or below the natural rate? c. so does the economy’s ability to increase long run supply. 69 . In terms of real GDP. show an increase in consumer confidence that increases AD by 1 billion at every level. show how an increase in technology would move the PPF and LRS. show how an increase in real balances changes the AD curve if AD increases by 1 billion at every level. Econexamcram on the iTunes Store. a. If the economy is left alone and the classical economists are right. a. Want more review? Checkout my iPod App. What is the effect on aggregate output? Explain why a change in AD was only inflationary. what is the new SR equilibrium? b. The economy’s productive capacity is captured in the production possibilities curve. 70 .LR8 (0) On the graph below. move AD so that the economy is in long run but not experiencing inflation. Want more review? Checkout my iPod App. Econexamcram on the iTunes Store. Explain what happens when there are further increases in AD. Solutions LRS1 recessionary gap LRS2 less than LRS3 LRS4 LRS5 AD would increase to 82. Workers would ask for a raise as the labor market is below its natural rate.5. the SRAS shifts to the left so that 82 billion in real GDP is produced but at a higher price level or P1. In the long run the only change is an increase in the price level. When wages increase. Econexamcram on the iTunes Store. Want more review? Checkout my iPod App. 71 . LRS6 LRS7 When any of the factors of production increases. 72 . Econexamcram on the iTunes Store. the PPF shifts to the right and so does the LRS curve. LRS8 LRS8 Want more review? Checkout my iPod App. Econexamcram on the iTunes Store. 73 .Want more review? Checkout my iPod App.