Economics Model Answers Twelve - 2013

(Difference between revisions)

Economics Homework - [1 - 2 - 3 - 4 - 5 - 6 - 7 - 9 - 10 - 11 - 12]

1. Which concept in Economics do you think is the best self-motivator, which you might use to achieve more?

Answers vary, but could include a discussion of opportunity costs, the benefits of competition, efficiency, maximizing marginal utility, Gresham's law, the Coase theorem, economic profits (as opposed to accounting profits), advantages of long run planning, how time is equivalent to money, etc.

2. Which is true about the average fixed costs (AFC) of a firm?

(a) A firm can eliminate these costs by shutting down in the short run.
(b) As output increases, AFC decreases.
(c) As output increases, AFC increases.
(d) AFC is part of average variable costs.

Briefly explain your answer.

B is the correct answer, because AFC is fixed costs divided by total output: FC/Q. As Q increases, the outcome decreases.

3. What is one of the primary responsibilities of the Federal Reserve Bank?

Control the interest rates of banks (which controls the flow of money), and keep banks from failing.

4. Review: Suppose that after completing this course, you start a new company. In your first year, you "broke even" (had zero profits), and in your second year you want to increase your revenue and profits. After careful study of your market, you decide that you can increase your revenue by increasing your price. Therefore your good must be price elastic/inelastic (choose one).

The good must be price inelastic.

5. A monopolistic competitive firm has the following characteristic that is lacking for a perfectly competitive firm:

(a) There are low barriers to entry.
(b) MR = MC in the long run.
(c) P > MC
(d) There are many competitors.

Choose one of the above and explain your answer.

The correct answer is "C". A monopolistic competitive firm has the characteristic "P > MC", which is not true for a perfectly competitive firm. A monopolistic competitive firm does not have to repeatedly lower its prices to keep up wih the competition. "A monopolistic competitive firm has the characteristic of P>MC, which is not true for a firm in perfect competition. This characteristic arises because the goods in monopolistic competitive firms are not perfect substitutes, and the price can be set higher than the marginal cost without a loss in revenue." (by student NL)

6. If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan? Give at least one reason.

Here are two reasons: the time value of money, and something extra to compensate you for taking the risk that your loan will not be paid back.

7. Review: is the cost of the bus for the March for Life trip to D.C. a "fixed cost" or a "variable cost"? Explain, assuming for the purpose of this question that one and only one bus can be used (in reality, we used several buses).

The cost of the bus is a fixed cost, because it is the same cost whether there is one person on the bus (or no one), and whether there are 47 people on the bus. The cost does not "vary" with the output.

8. Suppose I will pay you $1000 in two years, and the interest rate is 10% per year, compounded annually. How much should you pay me today to receive $1000 in two years? Show your work.

Work backwards: at 10% interest, $1000 in two years is the same as $1000/1.1=$909.09 in one year. That is because $909.09 generates $1000 in one year at 10% interest. Then we have to work backwards one more year to get to "today": $909.09/1.1=$826.45. So the answer is $826.45 - that is what we would need to receive today for it to be the same as $1000 in two years, at 10% interest compounded annually. Check our answer: $826.45 times 10% = $82.65. Add that and our total in one year is it would require $1000/1.1=$909.10. Repeat that process for the second year and the total is $909.10 plus $90.91=$1000.01 (the extra penny is due to rounding error).

9. Explain why in long-run equilibrium the price charged in monopolistic competition is greater than marginal cost but equal to average total cost.

In monopolistic competition there are almost no barriers of entry. A new firm can easily enter the market if products were selling above average total cost. If they charged more than ATC they would be undersold by the competition, and if they charged less then they would loss money overall. "In a firm in monopolistic competition, the long-run equilibrium price is equal to average total cost (ATC) because there are very few barriers to entry into the market. If price were greater than average total cost, then other firms would set their price lower (equal to ATC) in order to compete. In contrast, the price need not be equal to marginal cost (MC) in the short run since not all of the goods are perfect substitutes." (by student NL)

10. Economics is sometimes called the “dismal science” because economists predicted population to grow faster than the food supply, marginal returns to diminish, and profits to vanish. But, in fact, there is an abundance of food and profits have not vanished. Why is economics not so dismal after all?

Because new inventions and hard work by people create wealth, charity, ingenuity, and so on.

11. What is "Keynesian economics" and what is your view of it?

Keynesian economics claims that government interference, and especially government spending, is good for the economy.

12. An agreement by different firms with each other to reduce output is illegal. Why should that be illegal?

Yes, because reducing output is harmful to the public. In economic terms, reducing output causes a "deadweight loss."

13. Nash equilibrium, revisited: What is the Nash equilibrium for two gas stations (an oligopoly) that are situated immediately across the street from each other? In other words, what price do they sell at, expressed in terms of one of their cost measures? Explain the process that reaches that "equilibrium".

They sell at MR=MC. If one firm were to sell higher, than the other firm would boost its profits by reducing its price to where MR=MC. "The outcome would be when MR = MC. One gas station could lower its original price to get more business, but then the second station would lower its price as well so it doesn’t lose business. This would continue until both gas stations lower their prices to where cost equals price." (by student CM)

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Economics Model Answers Seven - 2013

(Difference between revisions)5.  Explain the difference between total cost, average cost, and marginal cost.5.  Explain the difference between total cost, average cost, and marginal cost.:Total cost is the entire costs that a firm has, including all fixed and variable costs. Average cost equals this total cost divided by the quantity of goods produced, which is TC/Q.  Marginal cost is the additional expense for making one additional unit.:Total cost is the entire expense that a firm has, including all fixed and variable costs. Average cost equals this total cost divided by the quantity of goods produced, which is TC/Q.  Marginal cost is the additional expense for making one additional unit.6.  Suppose you decide you could profitably set the price for a homeschool dinner event at $15 per ticket, and it would have attracted 150 people.  You also determine that 50 out of the 150 people who would have attended would have paid $20 per ticket and 10 out of the 150 would have paid $25 per ticket, and 5 out of the 150 would have paid $30 per ticket, because they would have enjoyed and benefited so much from it.  However, this homeschool dinner event was never held because no one "got around to it."  What is the loss in wealth or consumer surplus due to the fact that the event was ''not'' held?6.  Suppose you decide you could profitably set the price for a homeschool dinner event at $15 per ticket, and it would have attracted 150 people.  You also determine that 50 out of the 150 people who would have attended would have paid $20 per ticket and 10 out of the 150 would have paid $25 per ticket, and 5 out of the 150 would have paid $30 per ticket, because they would have enjoyed and benefited so much from it.  However, this homeschool dinner event was never held because no one "got around to it."  What is the loss in wealth or consumer surplus due to the fact that the event was ''not'' held?

Economics Homework - [1 - 2 - 3 - 4 - 5 - 6 - 7 - 9 - 10 - 11 - 12]

1. Identify the four elements of perfect competition.

1. Many buyers (consumers) and sellers (firms). 2. Goods that are perfect substitutes for each other. 3. A market where there is perfect knowledge needed to choose what to buy 4. A market that has perfect mobility or access to resources.

2. Describe how you might use competition, perhaps even competing with yourself, to motivate yourself to achieve more.

Set a goals for yourself each day. Write them down at the beginning of the day, and then "compete" with your list to see how many of the goals you achieve.

3. Write the equations for TC, FC, ATC, and AFC, and give an example of how they would be used.

TC = FC + TVC , which is the sum of the fixed cost and variable cost. Example: the total cost of running a gas station is the cost of the building and the gas pumps and the wages for the workers and the gasoline itself, which includes both fixed and variable costs. FC = TC when the quantity Q produced by your firm is zero. Example: the fixed cost (FC) for a restaurant is the cost of renting or buying the building, cooking equipment, and utensils such as forks and spoons. ATC = TC / Q , which is the average total cost per unit of the good produced. For example, if the total cost for making 100 pizzas a day is $500, then the average total cost (ATC) is $500 / 100 = $5 per pizza. AFC = FC / Q , which is the fixed cost per unit of the good produced. For example, if the fix cost of the pizza palor (just the building, cooking equipment, and utensils such as forks and spoons) is $300 per day, then the average fixed cost (AFC) is $300 / 100 = $3 per pizza.

4. Do you think the converse of Gresham's Law is true with respect to speech and conversation? Specifically, does good speech or conversation (such as discussing the Bible) drive out bad speech? Explain.

Yes, just as bad speech tends to drive out good speech, an effort at good speech (for example, talking about the Bible) does tend to drive out bad speech. But it takes effort, or else people seem to drive towards uninformative, unspiritual chatter.

5. Explain the difference between total cost, average cost, and marginal cost.

Total cost is the entire expense that a firm has, including all fixed and variable costs. Average cost equals this total cost divided by the quantity of goods produced, which is TC/Q. Marginal cost is the additional expense for making one additional unit.

6. Suppose you decide you could profitably set the price for a homeschool dinner event at $15 per ticket, and it would have attracted 150 people. You also determine that 50 out of the 150 people who would have attended would have paid $20 per ticket and 10 out of the 150 would have paid $25 per ticket, and 5 out of the 150 would have paid $30 per ticket, because they would have enjoyed and benefited so much from it. However, this homeschool dinner event was never held because no one "got around to it." What is the loss in wealth or consumer surplus due to the fact that the event was not held?

The loss in consumer surplus is the sum of the extra amount that everyone benefited above the $15 they paid for the tickets. The amount of this consumer surplus varies from individual to individual, and then it is all summed up. It is the extra amount that people would have paid, but did not have to because the ticket price was lower than what they would have paid. So the consumer surplus for this question is: 5 TIMES ($30 - $15) = $75 10 TIMES ($25 - $15) = $100 50 TIMES ($20 - $15) = $250 The total sum is $75 + $100 + $250 = $425 Thus the consumer surplus is $425.

7. Explain what the "CPI" is, and why the real price of a good is decreasing if its price remains constant while the CPI increases from year-to-year. An example of this might be the real price of laptop computers from 2012 to 2013.

The CPI is the Consumer Price Index, which helps measure inflation from month-to-month, based on how prices change for a set of non-farming goods. A CPI of "100" was the average for the period 1982-84. In January 2004, the CPI was 185.2, and in July 2009, the CPI was 215.351. This means that a dollar in 2009 was worth less than 1/2 the value of a dollar in 1982-1984, because a typical good (like a candy bar) cost more than twice as much as a typical good in 1982-1984. Laptop computers cost about the same in 2013 as 2012, but the CPI increased over that same time. This means the value of a dollar decreased from 2012 to 2013. If the same number of dollars can buy the same laptop in 2013 as 2012, than the real price of that laptop computer decreased

8. Explain what the Producer Surplus is, and provide an example.

Producer surplus is the wealth obtained by a seller (firm) because he was able to sell his good at a price higher than what he was willing to accept. Example: if supply equals demand for a new car at a price of $25,000, the car dealer will receive that price even though he would be willing to sell some of those new cars for less than $25,000. His producer surplus is the sum of all of the extra amounts he received above what he was really willing to sell each car for. On a supply-and-demand graph, the "producer surplus" is the area above the supply curve but below the line at the price where the good is sold.

9. Suppose the underlying labor market is perfectly competitive, but there is a minimum wage above the market rate. Then suppose that the supply of labor increases. Explain what the result is and why.

Unemployment increases, because there are no available jobs for the additional supply of labor.

10. What is the firm's profit or loss when Q=0 in the honors discussion above? (Answer simply in terms of another cost measure.) Is the firm profitable?

When Q=0 then the the firm's total cost (TC) is equal to its fixed cost (FC). The firm that shuts down is losing less money than if it stayed open and produced more Q, but the firm is still losing money. How much money does a firm that shuts down lost? Its total cost is equal its fixed cost: the firm has a loss of FC.

11. (Challenging, with extra credit) Prove mathematically that MC>MR for all Q>0 in the honors discussion above. (Hint: define MC in terms of the change in AVC, and then regroup the terms and draw conclusions about them to show MC>MR).

MR=P, and in perfect competition, AVC=MC. Here, when Q>0, AVC>MR, which is why the firm shuts down. But if AVC>MR, then AVC>P because P=MR. Because AVC=MC, then MC>P and MC>MR, as the question asked.

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Economics Model Answers Twelve - 2013

(Difference between revisions)4.  Review:  Suppose that after completing this course, you start a new company.  In your first year, you "broke even" (had zero profits), and in your second year you want to increase your revenue and profits.  After careful study of your market, you decide that you can increase your revenue by increasing your price.  Therefore your good must be price elastic/inelastic (choose one).4.  Review:  Suppose that after completing this course, you start a new company.  In your first year, you "broke even" (had zero profits), and in your second year you want to increase your revenue and profits.  After careful study of your market, you decide that you can increase your revenue by increasing your price.  Therefore your good must be price elastic/inelastic (choose one).:The good must be price inelastic.5.  A monopolistic competitive firm has the following characteristic that ''is lacking'' for a perfectly competitive firm:5.  A monopolistic competitive firm has the following characteristic that ''is lacking'' for a perfectly competitive firm:

1. Which concept in Economics do you think is the best self-motivator, which you might use to achieve more?

Answers vary, but could include a discussion of opportunity costs, maximizing marginal utility, economic costs, advantages of long run planning, how time is equivalent to money, etc.

2. Which is true about the average fixed costs (AFC) of a firm?

(a) A firm can eliminate these costs by shutting down in the short run.
(b) As output increases, AFC decreases.
(c) As output increases, AFC increases.
(d) AFC is part of average variable costs.

Briefly explain your answer.

B is the correct answer, because AFC is fixed costs divided by total output: FC/Q. As Q increases, the outcome decreases.

3. What is one of the primary responsibilities of the Federal Reserve Bank?

Control the interest rates of banks (which controls the flow of money), and keep banks from failing.

4. Review: Suppose that after completing this course, you start a new company. In your first year, you "broke even" (had zero profits), and in your second year you want to increase your revenue and profits. After careful study of your market, you decide that you can increase your revenue by increasing your price. Therefore your good must be price elastic/inelastic (choose one).

The good must be price inelastic.

5. A monopolistic competitive firm has the following characteristic that is lacking for a perfectly competitive firm:

(a) There are low barriers to entry.
(b) MR = MC in the long run.
(c) P > MC
(d) There are many competitors.

Choose one of the above and explain your answer.

The correct answer is "C". A monopolistic competitive firm has the characteristic "P > MC", which is not true for a perfectly competitive firm. A monopolistic competitive firm does not have to repeatedly lower its prices to keep up wih the competition.

6. If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan? Give at least one reason.

Here are two reasons: the time value of money, and something extra to compensate you for taking the risk that your loan will not be paid back.

7. Review: is the cost of the bus for the March for Life trip to D.C. a "fixed cost" or a "variable cost"? Explain, assuming for the purpose of this question that one and only one bus can be used (in reality, we used several buses).

The cost of the bus is a fixed cost, because it is the same cost whether there is one person on the bus (or no one), and whether there are 47 people on the bus. The cost does not "vary" with the output.

8. Suppose I will pay you $1000 in two years, and the interest rate is 10% per year, compounded annually. How much should you pay me today to receive $1000 in two years? Show your work.

Work backwards: at 10% interest, $1000 in two years is the same as $1000/1.1=$909.09 in one year. That is because $909.09 generates $1000 in one year at 10% interest. Then we have to work backwards one more year to get to "today": $909.09/1.1=$826.45. So the answer is $826.45 - that is what we would need to receive today for it to be the same as $1000 in two years, at 10% interest compounded annually. Check our answer: $826.45 times 10% = $82.65. Add that and our total in one year is it would require $1000/1.1=$909.10. Repeat that process for the second year and the total is $909.10 plus $90.91=$1000.01 (the extra penny is due to rounding error).

9. Explain why in long-run equilibrium the price charged in monopolistic competition is greater than marginal cost but equal to average total cost.

In monopolistic competition there are almost no barriers of entry. A new firm can easily enter the market if products were selling above average total cost. If they charged more than ATC they would be undersold by the competition, and if they charged less then they would loss money overall.

10. Economics is sometimes called the “dismal science” because economists predicted population to grow faster than the food supply, marginal returns to diminish, and profits to vanish. But, in fact, there is an abundance of food and profits have not vanished. Why is economics not so dismal after all?

Because new inventions and hard work by people create wealth, charity, ingenuity, and so on.

11. What is "Keynesian economics" and what is your view of it?

Keynesian economics claims that government interference, and especially government spending, is good for the economy.

12. An agreement by different firms with each other to reduce output is illegal. Why should that be illegal?

Yes, because reducing output is harmful to the public.

13. Nash equilibrium, revisited: What is the Nash equilibrium for two gas stations (an oligopoly) that are situated immediately across the street from each other? In other words, what price do they sell at, expressed in terms of one of their cost measures? Explain the process that reaches that "equilibrium".

They sell at MR=MC. If one firm were to sell higher, than the other firm would boost its profits by reducing its price to where MR=MC.

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The Science Of Human Nature Is Proving Classical Economics False. What Comes Next?

In a previous post, I wrote about the emerging view of human nature as fundamentally cooperative and group-oriented rather than simply self-interested as most conservatives believe.  I noted that this paradigm shift has important implications for progressives in a political sense.  We should not shy away from appeals to cooperative instincts and the common good because they are “fuzzy” and “soft”.  Instead they should be front and center because they touch something deep within our basic nature.

But that’s not all the implications of these new findings.  There are also very important implications for economic policy.  Start with middle class economics.  This school of thought, associated with progressive economists like Robert Reich, Joseph Stiglitz, Paul Krugman and progressive institutions like (ahem) the Center for American Progress, ties progressive policy proposals directly to the interests and capabilities of the middle class. Since the middle class as a group embraces a huge swathe of American society, this is a very promising framework for a group-oriented appeal.

The new theory of human nature also casts considerable doubt on the standard model of economics, based around neoclassical assumptions that people are solely motivated by self-interested concerns.  As we have just seen, they aren’t, which poses a rather fundamental problem for mainstream economics.  The problem deepens when the other key part of the standard economic model is recalled: people rationally, efficiently and effectively pursue that self-interest at all times, carefully calculating probabilities and assessing costs and benefits so they can get the best possible deal for themselves—like a sort of self-interested Mr. Spock.  People aren’t like that either, as the evolving science of behavioral economics has clearly established.

Behavioral economics has found, based on observation of actual people making decisions, that people don’t understand probability, under- and over-estimate risk, respond heavily to how choices are framed and generally fail, in a wide variety of contexts, to “rationally” pursue their goals.  These results, now widely accepted even within mainstream economics, have been well-summarized by Cass Sustein and Richard Thaler in their book Nudge and by Daniel Kahneman in his book Thinking Fast and Slow.

So we’re not purely self-interested and we do a spotty job of pursuing that self-interest when we try.  What does this say about standard models of the economy based on aggregating the assumed efficient, self-interested actions of millions and “proving” that everything works out for the best if those efficient, self-interested individuals are left alone?  Nothing good.

And indeed nothing good has come out of applying that model for three decades.  There has been no growth boom and no rapid rise in living standards.  In fact, both overall economic growth and, especially, living standards growth have been relatively slow by historical standards.  And instead of unleashing a frenzy of creative solutions to long-standing economic problems, deregulated economies have just made most of them worse: more speculative bubbles; more risky investments; more inequality; more unemployment; more bad jobs; and so on.  Finally, risky economic behavior got completely out of control and the resulting financial meltdown sent the economy into the biggest nose-dive since the Great Depression.

It’s fair to say the mainstream economic model now lies in ruins.  Its core assumptions have been tested and found wanting.  Unleashing purely rational, purely self-interested individuals to do whatever they want has proved to be a recipe for stagnation at best and utter disaster at worst.  And the reason is simple: these individuals don’t exist and never will.  Therefore, the market will never work as the current standard economic model says it should.  Instead, an effective economics should accept the preferences and inclinations of actually-existing people and reject the limits that imaginary perfect markets supposedly put on economic objectives.

These points have been made and made forcefully by very prominent progressive economists like Krugman, Stiglitz, George Akerlof and Robert Shiller among many others.   But, as noted recently by economic journalist John Cassidy, we have yet to see the emergence of a “new Keynes” with a positive theory of how the economy works that can replace the standard model.  That is not to say there are not at least the beginnings of such a theory.  Again, the emerging middle class economics school of thought is starting to generate both the theoretical and empirical work that could lead to a true alternative paradigm to neoclassical economics.

But as yet there is no worked-out theory that connects the microfoundations of actual human behavior to the macro outcomes that economic policy is concerned with.  The microfoundations of the standard model—completely self-interested homo economicus—however unrealistic are mathematically tractable in a way that lends itself to macro analysis.  The same is not true for our new, more accurate, but complicated, understanding of human motivation.   But the micro-macro connection will have to be bridged if our new Keynes is to emerge and consolidate a theory to guide a new era of capitalist growth.

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Economics Model Answers Twelve - 2013

(Difference between revisions)1.  Which concept in Economics do you think is the best self-motivator, which you might use to achieve more?1.  Which concept in Economics do you think is the best self-motivator, which you might use to achieve more?:Answers vary, but could include a discussion of opportunity costs, maximizing marginal utility, economic costs, advantages of long run planning, how time is equivalent to money, etc.2.  Which is true about the average fixed costs (AFC) of a firm?2.  Which is true about the average fixed costs (AFC) of a firm?:B is the correct answer, because AFC is fixed costs divided by total output: FC/Q. As Q increases, the outcome decreases.3.  What is one of the primary responsibilities of the Federal Reserve Bank?  3.  What is one of the primary responsibilities of the Federal Reserve Bank?  :Control the interest rates of banks (which controls the flow of money), and keep banks from failing.4.  Review:  Suppose that after completing this course, you start a new company.  In your first year, you "broke even" (had zero profits), and in your second year you want to increase your revenue and profits.  After careful study of your market, you decide that you can increase your revenue by increasing your price.  Therefore your good must be price elastic/inelastic (choose one).4.  Review:  Suppose that after completing this course, you start a new company.  In your first year, you "broke even" (had zero profits), and in your second year you want to increase your revenue and profits.  After careful study of your market, you decide that you can increase your revenue by increasing your price.  Therefore your good must be price elastic/inelastic (choose one).5.  A monopolistic competitive firm has the following characteristic that ''is lacking'' for a perfectly competitive firm:5.  A monopolistic competitive firm has the following characteristic that ''is lacking'' for a perfectly competitive firm:Choose one of the above and explain your answer.Choose one of the above and explain your answer.:The correct answer is "C".  A monopolistic competitive firm has the characteristic "P > MC", which is not true for a perfectly competitive firm. A monopolistic competitive firm does not have to repeatedly lower its prices to keep up wih the competition. 6.  If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan?  Give at least one reason.6.  If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan?  Give at least one reason.9.  Explain why in long-run equilibrium the price charged in monopolistic competition is greater than marginal cost but equal to average total cost.9.  Explain why in long-run equilibrium the price charged in monopolistic competition is greater than marginal cost but equal to average total cost.:In monopolistic competition there are almost no barriers of entry. A new firm can easily enter the market if products were selling above average total cost.  If they charged more than ATC they would be undersold by the competition, and if they charged less then they would loss money overall.10.  Economics is sometimes called the “dismal science” because economists predicted population to grow faster than the food supply, marginal returns to diminish, and profits to vanish.  But, in fact, there is an abundance of food and profits have not vanished.  Why is economics not so dismal after all?10.  Economics is sometimes called the “dismal science” because economists predicted population to grow faster than the food supply, marginal returns to diminish, and profits to vanish.  But, in fact, there is an abundance of food and profits have not vanished.  Why is economics not so dismal after all?:Because new inventions and hard work by people create wealth, charity, ingenuity, and so on.11.  What is "Keynesian economics" and what is your view of it?11.  What is "Keynesian economics" and what is your view of it?:Keynesian economics claims that government interference, and especially government spending, is good for the economy.12.  An agreement by different firms with each other to reduce output is illegal.  Why should that be illegal?12.  An agreement by different firms with each other to reduce output is illegal.  Why should that be illegal?13.  Nash equilibrium, revisited:  What is the Nash equilibrium for two gas stations (an oligopoly) that are situated immediately across the street from each other?  In other words, what price do they sell at, expressed in terms of one of their cost measures?  Explain the process that reaches that "equilibrium".13.  Nash equilibrium, revisited:  What is the Nash equilibrium for two gas stations (an oligopoly) that are situated immediately across the street from each other?  In other words, what price do they sell at, expressed in terms of one of their cost measures?  Explain the process that reaches that "equilibrium".[[Category:Economics lectures]]

1. Which concept in Economics do you think is the best self-motivator, which you might use to achieve more?

Answers vary, but could include a discussion of opportunity costs, maximizing marginal utility, economic costs, advantages of long run planning, how time is equivalent to money, etc.

2. Which is true about the average fixed costs (AFC) of a firm?

(a) A firm can eliminate these costs by shutting down in the short run.
(b) As output increases, AFC decreases.
(c) As output increases, AFC increases.
(d) AFC is part of average variable costs.

Briefly explain your answer.

B is the correct answer, because AFC is fixed costs divided by total output: FC/Q. As Q increases, the outcome decreases.

3. What is one of the primary responsibilities of the Federal Reserve Bank?

Control the interest rates of banks (which controls the flow of money), and keep banks from failing.

4. Review: Suppose that after completing this course, you start a new company. In your first year, you "broke even" (had zero profits), and in your second year you want to increase your revenue and profits. After careful study of your market, you decide that you can increase your revenue by increasing your price. Therefore your good must be price elastic/inelastic (choose one).

The price must be inelastic.

5. A monopolistic competitive firm has the following characteristic that is lacking for a perfectly competitive firm:

(a) There are low barriers to entry.
(b) MR = MC in the long run.
(c) P > MC
(d) There are many competitors.

Choose one of the above and explain your answer.

The correct answer is "C". A monopolistic competitive firm has the characteristic "P > MC", which is not true for a perfectly competitive firm. A monopolistic competitive firm does not have to repeatedly lower its prices to keep up wih the competition.

6. If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan? Give at least one reason.

7. Review: is the cost of the bus for the March for Life trip to D.C. a "fixed cost" or a "variable cost"? Explain, assuming for the purpose of this question that one and only one bus can be used (in reality, we used several buses).

8. Suppose I will pay you $1000 in two years, and the interest rate is 10% per year, compounded annually. How much should you pay me today to receive $1000 in two years? Show your work.

9. Explain why in long-run equilibrium the price charged in monopolistic competition is greater than marginal cost but equal to average total cost.

In monopolistic competition there are almost no barriers of entry. A new firm can easily enter the market if products were selling above average total cost. If they charged more than ATC they would be undersold by the competition, and if they charged less then they would loss money overall.

10. Economics is sometimes called the “dismal science” because economists predicted population to grow faster than the food supply, marginal returns to diminish, and profits to vanish. But, in fact, there is an abundance of food and profits have not vanished. Why is economics not so dismal after all?

Because new inventions and hard work by people create wealth, charity, ingenuity, and so on.

11. What is "Keynesian economics" and what is your view of it?

Keynesian economics claims that government interference, and especially government spending, is good for the economy.

12. An agreement by different firms with each other to reduce output is illegal. Why should that be illegal?

13. Nash equilibrium, revisited: What is the Nash equilibrium for two gas stations (an oligopoly) that are situated immediately across the street from each other? In other words, what price do they sell at, expressed in terms of one of their cost measures? Explain the process that reaches that "equilibrium".

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Economics Lecture Thirteen

(Difference between revisions)== Review: Different Types of Markets ==== Review: Different Types of Markets ==You instructor wonders what topic will maximize our marginal utility next.  About 20% of the exam is devoted to questions about different types of markets, ranging from the most advantageous for the public (perfect competition) to the least advantageous for the public (monopoly).  That's a large chunk of questions, and with some extra review here we can probably potential convert wrong answers to right ones.You instructor wonders what topic will maximize our marginal utility next.  About 20% of the exam is devoted to questions about different types of markets, ranging from the most advantageous for the public (perfect competition) to the least advantageous for the public (monopoly).  That's a large chunk of questions, and with some extra review here students can convert potentially wrong answers into correct ones.The key to answering these questions correctly is to realize that the more competition there is, the lower the price of the goods and services and the lower the profits for the firms.  Some of these questions are special cases and should simply be memorized:  a cartel is an oligopoly that illegally agrees to fix (set) its prices, and an oligopoly is an industry where just a few firms dominate the market.  When given a grid about where an oligopoly ends up selling its goods (its Nash Equilibrium), the answer is always symmetric (all firms sell at the same price) and usually not the highest price that a monopoly could sell at.The key to answering these questions correctly is to realize that the more competition there is, the lower the price of the goods and services and the lower the profits for the firms.  Some of these questions are special cases and should simply be memorized:  a cartel is an oligopoly that illegally agrees to fix (set) its prices, and an oligopoly is an industry where just a few firms dominate the market.  When given a grid about where an oligopoly ends up selling its goods (its Nash Equilibrium), the answer is always symmetric (all firms sell at the same price) and usually not the highest price that a monopoly could sell at.There can be general questions about these markets.  A perfectly competitive market uses resources in a perfectly efficient way.  At the other end of the spectrum, a monopoly uses resources the least efficiently of all.  Its high pricing causes a huge social loss ("deadweight loss") by eliminating consumer surplus.  The monopoly reduces output in order to cause a scarcity that increases the price to an artificially high level.  This is bad for everyone, except the owner of the monopoly, who enriches himself.  This is how Bill Gates became the wealthiest person in the world.There can be general questions about these markets.  A perfectly competitive market uses resources in a perfectly efficient way.  At the other end of the spectrum, a monopoly uses resources the least efficiently of all.  Its high pricing causes a huge social loss ("deadweight loss") by eliminating consumer surplus.  The monopoly reduces output in order to cause a scarcity that increases the price to an artificially high level.  This is bad for everyone, except the owner of the monopoly, who enriches himself.  This is how Bill Gates became the wealthiest person in the world.Here is a puzzle to leave you with.  What is the impact on quantity of a price ceiling in a competitive industry compared to a price ceiling in a monopoly?  In which one (competitive v. monopoly) might a clever price ceiling actually increase quantity?  Think about it, and learn to ask yourself questions like this in order to master economics.  The answer is in this footnote.A price ceiling is a maximum price limitation, just as a real ceiling in house limits the height.  A perfectly competitive industry is already selling at its maximum output, so a price ceiling can't help there.  But a monopoly increases its price by reducing its output.  If a price ceiling is imposed against a monopoly, then it must reduce its price and increase its output, which benefits the public.Here is a puzzle to leave you with.  What is the impact on quantity of a price ceiling in a competitive industry compared to a price ceiling in a monopoly?  In which one (competitive v. monopoly) might a clever price ceiling actually increase quantity?  Think about it, and learn to ask yourself questions like this in order to master economics.  The answer is in this footnote.A price ceiling is a maximum price limitation, just as a real ceiling in a house limits the height.  A perfectly competitive industry is already selling at its maximum output, so a price ceiling can't help there.  But a monopoly increases its price by reducing its output.  If a price ceiling is imposed against a monopoly, then it must reduce its price and increase its output, which benefits the public.Be sure to spend time on the review sections in the prior lectures for more information about this and other topics on the exams.Be sure to spend time on the review sections in the prior lectures for more information about this and other topics on the exams.:(E) increase labor until the ratio of the price of the output to labor's marginal product equals the wage rate:(E) increase labor until the ratio of the price of the output to labor's marginal product equals the wage rateThis type of question benefits from being reread.  “Capital is fixed,” according to the question.  So capital cannot be increased.  Answers (A) and (C) can be eliminated that easily.  Many students miss the obvious sometimes on economics exams.  They fail to read and understand the question.This type of question benefits from being reread.  “Capital is fixed,” according to the question.  So capital cannot be increased.  Answers (A) and (C) can be eliminated that easily.  Many students sometimes miss the obvious on economics exams.  They fail to read and understand the question.Only labor can be increased, which is possible under answers (B), (D) and (E).  We've improved our odds of success to a 33% chance.  Those are good odds on a difficult question like this.  But we can improve our chances even more.Only labor can be increased, which is possible under answers (B), (D) and (E).  We've improved our odds of success to a 33% chance.  Those are good odds on a difficult question like this.  But we can improve our chances even more.

Economics Lectures - [1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 - 10 - 11 - 12 - 13 - 14]

This lecture is the final review for this course, in preparation for the final exam. A student who took this class in 2007 sent me the following feedback from college:

My microeconomics class has been almost all review for me, because of the similar class I took from Mr. Andy Schlafly .... Although other students who attended public schools may have taken 'economics' before, they have struggled with microeconomics this semester, because their high school classes completely ignored the free-market and Austrian economics[1] which are taught [in college].

Let's begin this lecture by summarizing the percentages the CLEP exam devoted to particular topics. This will help organize the material we have covered in this course. Our online final exam next week will use a similar distribution in topics as the CLEP exam, but without over-emphasizing government policy as the CLEP exam does.

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Here is a list of the topics on the CLEP exam, along with how many questions are asked about each topic (as a percentage of the overall exam), plus tips about each concept:

cost measures (e.g., ATC, AFC, AVC) FC is total cost when output is zero; convert to average costs by dividing by output. Remember that ATC=AFC+AVC, and know when a firm should shut down. price ceilings cause shortages and taxes cause social (deadweight) loss; but beware of CLEP questions designed to make government regulation appear beneficial, as in reducing pollution Inputs to a Firm (espec. labor) key here is applying logic and other concepts to reason back from product demand to a firm's need for labor (workers); know effects of minimum wage laws; might also be asked about capital costs and profits and price are lowest for this type of market. P=MC=ATC and "economic profits" are squeezed to zero. If price falls, shut down in short run when PMC. P>ATC. what the public will pay; all firms in all kinds of markets are restrained by the Law of Demand marginal revenue is the increase in total revenue due to selling one more unit; profit maximized where MR=MC marginal cost, which equals price in perfect competition. For a monopoly P>MC but equals MR=MC know the difference between these and private goods: public goods cannot exclude people from using the good without paying for it. think of Wal-Mart for increasing returns to scale; think of a kitchen for decreasing returns to scale ("too many cooks spoil the broth") what someone was willing to pay above what the good actually cost nation with lower production costs should do what it does best only a few firms, like two gas stations at an intersection far away from any others; usually one Nash Equilibrium-type exam question P>MC for this market, which is "allocatively inefficient" (is not efficient in the allocation of resources); it takes perfect competition to drive P down to MC overall satisfaction; recall our problem about hiking and reading. Marginal utility is your next bit of utility. Indifference curve shows trade-off in utility. Comparing change in demand for one good due to change in price for a different good keep in mind that "economic costs" include opportunity costs in addition to actual out-of-pocket (accounting) costs think ketchup with French fries in the long run all costs are variable and can be minimized; short and long run mentioned in 20% of questions, to distinguish between quick changes and permanent ones two types: positive (music in an open-air park) and negative (pollution) when income goes up, demand for an inferior good or service goes down (e.g., demand for bankruptcy services) substitution and income effects increase in price means less demand because public uses substitutes (substitution effect of price increase) and becomes poorer (income effect of price increase) an oligopoly that illegally agrees to fix (set) prices, as OPEC does charging different prices for the exact same good; only possible if the market allows the firm to set its own price

Some important topics are missing from the CLEP exam, such as the invisible hand, free market, charity, transaction costs, the time value of money, interest rates, the Coase theorem and Gresham's Law. The reason is exam bias. For example, once a student realizes how inefficient transaction costs are, he or she will probably not like government regulations much! Instead of these concepts, the CLEP exam adds lots of questions about government regulation to try to make regulation look good. But other than bias in the selection of question, bias is rare in answers to economics questions. Pick the answer that you think is correct, without worrying about bias.

As always, be sure you fully understand the question before you answer it, and use common sense and logic. In fact, many economics questions can be answered correctly with patience and basic reasoning skills.

Let's put our knowledge from this course to good use in studying for our final exam, and preparing for the CLEP exam. We maximize our utility by scoring as high as possible on these exams. To do so, we need to maximize our marginal utility in allocating our time towards the exam topics listed above. If we spend all our studying time on "price discrimination," which is only 1% of the exam, then we are not maximizing our marginal utility and will not reach our full potential.

This is similar to our homework problem earlier in the course about maximizing our marginal utility with respect to hiking and reading. This time, however, the decision each student must make is which topic to focus on first in the above list, and how much time to spend on it before moving on to another topic in the list. The answer may be different for each student.

This same challenge in optimizing strategy could be expressed as a problem of "allocative efficency": allocating resources (time and information) in the most efficient way. Just as efficiency is essential to successful businesses, efficiency is also important to becoming a successful student. Spending your time efficiently in preparing for the final exam, and preparing for the CLEP, is crucial to your ability to do well on them. Look at the above list of topics and how often they appear, and ask yourself: where should you focus first in order to pick up the most points in the shortest amount of time?

Should you simply start reviewing at the top of the list and work your way down to the bottom? That strategy has the advantage of focusing on the most important topics first. If you run out of time in reviewing, then you will miss only the less important topics. But you might improve further on that strategy by moving more quickly through topics that you already understand well. Alternative, there may be topics that you find too difficult to understand, and you might give up some points there in order to focus better on topics where you can pick up more points.

For the rest of this class this lecture will focus on topics which might provide the greatest marginal increase in your exam scores. This takes into consideration the topics we have already reviewed (you have the materials for those), and avoids duplication of that review. You may, however, decide for yourself that you can benefit most from reviewing those prior topics.

Your instructor emphasizes studying strategy for a reason. The biggest reason why some students do not succeed is a lack of effort. But the second biggest reason is poor studying and test-taking strategies, like a football team that runs ill-advised plays. Education, like business and perhaps even life itself, rewards good strategies and punishes misguided ones.

For many students, the most additional points can be obtained by reviewing the "Inputs to a Firm" category. It will be on 10% of the questions on the final exam and the CLEP exam. That's a significant chunk of these exams. Without review, these questions look hard and are easy to miss. But with some extra preparation, you should be able to answer nearly all of them correctly. In maximizing your score and making the best use of your time, this category may result in the biggest increase in correct answers with the least amount of effort. That's what maximizing marginal utility is all about.

Accordingly, in economic terms, the greatest marginal utility from studying for the exam is probably obtaining by focusing on this topic first. We've already covered the other two topics comprising 10% apiece of the exam (cost measures and government regulation), so there may not be many more points to pick up there. Realize that you will probably get some exam questions right without additional studying, and other questions you may get wrong no matter how much you study. But in this category of "inputs to a firm," you can pick up some points that you would otherwise miss. Let's review it now.

Questions about inputs to a firm focus on what a firm will do with its inputs (typically labor, but sometimes capital) in order to maximize its profits. The questions usually concern the following:

impact of improvement in technology on the production by a firm adjusting inputs to minimize the overall cost at a constant level of output the effect of minimum wage on the competition for labor comparing the cost of an input (usually labor) relative to the additional revenue that results why a firm's "demand for labor" is called a "derived demand" what causes an increase in demand for labor the relation between hiring additional workers and the marginal cost calculating overall costs (total cost and average variable cost) based on wages

Review the above list now. How many of the above 8 topics do you know well enough to answer a question about them correctly? Let's briefly review each of these concepts so you can maximize your score on this big part of the exam.

1. "the impact of an improvement in technology on the production by a firm"

If technology improves, as in helpful new inventions or advances in communication (like the internet), then this helps shift the Production Possibilities Frontier (Curve) outward. A firm can produce more output now. So an improvement in technology enables a firm to increase its output or its supply to the market.

2. "adjusting inputs to minimize the overall cost at a constant level of output"

How does a firm adjust its inputs (e.g., workers or equipment) so that the firm reaches its lowest possible overall cost? By making sure that the firm is getting the most for each input. In other words, the firm makes sure that each input is producing the most marginal product per dollar spent on that input. If one worker is producing more than another worker, and both are being paid the same, then the owner has not lowered his costs to a minimum. He could fire the lazy worker and hire a part-time worker like his good one, and then produce the same output at less cost. Summarizing the above, a firm minimizes its overall costs by making sure the marginal product per cost for each input is equal. If one input (e.g., one worker) is producing more marginal product per cost than another, then the overall costs are not minimized. The unproductive worker is wasting the firm's money.

3. "the effect of the minimum wage on the competition for labor"

Increasing the minimum wage has the effect of increasing unemployment. Workers who have jobs make more money when the minimum wage is increased, but firms can afford to hire fewer people. The number of the unemployed (the people who cannot get jobs) increases when the minimum wage is increased. Also, although this will never be asked on a CLEP exam, raising the minimum wage causes more high school students to drop out and pursue jobs rather than stay in school, which would enable them to obtain higher-paying jobs in the future. Sometimes the CLEP exam will twist the question about minimum wage to obscure its harmful effect, by asking what happens when the labor supply increases when there already is a minimum wage. This makes it look like the fault is an increase in the labor supply rather than the minimum wage law. The correct answer is the same in both cases: unemployment increases.

4. "comparing the cost of an input (usually labor) relative to the additional revenue that results"

This type of question probes how a firm increases its inputs in relation to the additional revenue that results from such an increase. The key here is to be very careful and very logical. A firm will increase an input (such as labor) until the value of the marginal product of that input equals the marginal cost of that input. Read that sentence over and over until you understand it. It simply means that the firm will equate the marginal cost of the additional input (such as an additional worker) to the marginal revenue that the additional input produces. Often students miss this type of question because they are not careful to compare dollars to dollars. If you have the marginal cost in terms of dollars (such as a wage rage for the additional worker), then you need to equate it to the marginal value of the marginal product of the labor (value is in dollar units), not the marginal product itself (which is a unit quantity).

5. "why a firm's "demand for labor" is called a "derived demand"

This is an easy point to pick up on an exam. A firm's demand for an input (such as labor) is called a "derived demand" because it depends on the demand for the goods produced by that input. For example, a restaurant's demand for waitresses is entirely dependent on the public's demand to be served at the restaurant. If there is no public demand to be waited on at the restaurant, then the restaurant (the firm) has no demand for waitresses!

6. "what causes an increase in demand for labor"

This is another easy issue, similar to the prior one above. If the public demand for the product of the labor increases, then there is an increase in demand for the labor itself. If more people want to eat McDonald's hamburgers, then there is more demand for workers to make McDonald's hamburgers. How do we know when the demand by the public for the product of certain labor increases? When the price of the good or service produced by the labor increases. When that price goes up, then there is an increase in demand for the workers who make that good or service.

7. "the relation between hiring additional workers and the marginal cost"

This is a more challenging issue that requires two steps rather than one in order to answer correctly. Marginal cost is additional cost to a firm for making one more unit. It is measured in dollars, not in units. Making sure you have the right measure (dollars or units) for your answer will help you reduce mistakes. The answer for any question about marginal cost must be in dollars (or cents) per unit. Accordingly, if you are told how many additional units are produced by each additional worker, then calculating the marginal cost requires dividing the cost of the additional worker by the additional number of units he produces. The more units an additional worker produces, the lower the marginal cost that results from adding that worker. Example: suppose a firm hires Tom and sees the output increase by 20 units, and then hires Mary at the same wage and sees the output increase by 15 units. When is the marginal cost of the firm the lowest? After it hires Tom, but before it hires Mary. That's because the marginal cost of hiring Tom is his wages divided by 20, while the marginal cost of hiring Mary is the same wage divided by 15. A wage divided by 20 is less than the same wage divided by 15, so the marginal cost to the firm after hiring Tom is less than after hiring Mary.

8. "calculating overall costs (total cost and average variable cost) based on wages"

The key here is simply to be careful in doing the calculations, and then double-check your answer. You need to be sure you are using the correct level of output before you calculate the total cost (TC) and average variable cost (AVC) at that level of output. To find the total cost, add the fixed cost (FC) to the variable cost (the variable cost is usually the labor cost: total wages times the number of workers), for a given level of output. Then, to find the average variable cost, find the total variable cost (TVC=TC-FC) and divide by that level of output. Example: a firm can produce 100 units with 5 workers and 200 units with 10 workers. Its fixed cost is $50 and its wage rate is $20 per worker. What is its total cost and average variable cost to produce 100 units? Answer: notice first that the question asks about the costs at 100 units in output, not 200 units. Total cost at 100 units is the fixed cost ($50) plus the labor cost ($20 times 5 workers, or $100), for a total of $150. The average variable cost is the total cost ($150) minus the fixed cost ($50), divided by the output (100), for a total of $1 per unit.

Master the above eight issues, and you'll convert 10% of the exam from wrong answers to correct ones. That could enable you to earn college credit.

You instructor wonders what topic will maximize our marginal utility next. About 20% of the exam is devoted to questions about different types of markets, ranging from the most advantageous for the public (perfect competition) to the least advantageous for the public (monopoly). That's a large chunk of questions, and with some extra review here students can convert potentially wrong answers into correct ones.

The key to answering these questions correctly is to realize that the more competition there is, the lower the price of the goods and services and the lower the profits for the firms. Some of these questions are special cases and should simply be memorized: a cartel is an oligopoly that illegally agrees to fix (set) its prices, and an oligopoly is an industry where just a few firms dominate the market. When given a grid about where an oligopoly ends up selling its goods (its Nash Equilibrium), the answer is always symmetric (all firms sell at the same price) and usually not the highest price that a monopoly could sell at.

The monopoly questions look harder than they really are. The monopolist sets his price higher than marginal cost, which would be the optimal price from the standpoint of the public (or government). Instead, the monopolist price sets his price where marginal revenue equals marginal cost (MR=MC). If shown a graph, you may have to find the quantity where MR=MC, and then find the corresponding price on the demand curve. Notice that a monopolist has no supply curve, because a supply curve represents many firms in an industry and a monopolist is the only firm in the industry.

There can be general questions about these markets. A perfectly competitive market uses resources in a perfectly efficient way. At the other end of the spectrum, a monopoly uses resources the least efficiently of all. Its high pricing causes a huge social loss ("deadweight loss") by eliminating consumer surplus. The monopoly reduces output in order to cause a scarcity that increases the price to an artificially high level. This is bad for everyone, except the owner of the monopoly, who enriches himself. This is how Bill Gates became the wealthiest person in the world.

Here is a puzzle to leave you with. What is the impact on quantity of a price ceiling in a competitive industry compared to a price ceiling in a monopoly? In which one (competitive v. monopoly) might a clever price ceiling actually increase quantity? Think about it, and learn to ask yourself questions like this in order to master economics. The answer is in this footnote.[2]

Be sure to spend time on the review sections in the prior lectures for more information about this and other topics on the exams.

A public good is a good which is nonexcludable and nondepletable. The first condition means that it is impossible to exclude consumers from partaking in the good, and the second condition means that one consumer's consumption of the good does not prevent others from consuming it.

Explained another way, a public good is available to all such that consumption by one person does not reduce its availability to others. An example of a public good is national defense, as it protects everyone and its benefits to one person do not diminish its benefits to others.

Other examples of public goods are law enforcement (protection by the police), public fireworks, clear air, street lights, radio and television transmissions, lighthouses, and some inventions. Some of these examples, such as lighthouses, are contested as to whether they must be a public good, as it is possible to charge ships port fees to pay for them. Also, while radio and television transmissions are available to all to receive them, it does cost money to buy radios and television sets, so these are not truly public goods either.

Liberals like to emphasize the concept of public goods on exams in order to support the argument for more government. Under this view public goods represent market failure and the need for government services supported by taxes.

Good test-taking techniques are particularly important to doing well on an economics exam. Simple questions are often intentionally disguised as something more complicated. It is easy to become confused and misguided in analyzing economic issues. 99% of the public would say that we would be better off if Congress put a price ceiling or cap on gasoline at $1 a gallon. It takes a bit more thought to realize that massive shortages would result, and we would all have to waste hours each week waiting in line for gasoline. Some who really need gas in hurry, such as people trying to take someone to a hospital, may not be able to obtain gas in time.

The ability to eliminate wrong answers can help. Let’s try the elimination technique on these questions:

Question: Consider the poverty-level of income for a family of four in America. Which of the following can be said about how the government defines this specific income level?

(A) It helps determine who is eligible for Social Security benefits. (B) It decreases when there is an increase in welfare benefits. (C) It proves that 50% of Americans live in poverty. (D) It is determined by tripling the cost of a nutritionally adequate diet by three. (E) Government does not adjust this number due to changes in the cost of living (inflation).

Virtually none of you would know the answer to this question at first glance. This question is not really appropriate for a "micro"-economics exam ("micro"-economics concerns individual buying and selling decisions), but CLEP asks it anyway. Questions about poverty, gaps between the rich and poor, and government programs are always favorites among liberal educators. You will see many more questions about these issues than about the invisible hand or the creation of wealth.

So what do we do when faced with this question? Simply give up? Move to the next question and hope it is easier? Blindly guess at an answer? None of the above.

We can narrow the choices, and thereby reduce our risk of error, by eliminating wrong answers. Basic economic principles (or common sense) serve as our guide.

Let’s start with choice (C). Think about it: is half of our nation living in poverty? What would that mean for elections? Who would pay to run government? If we called half of us "poor", then what word would be use for the really poor? Choice (C) can't be true. Using common sense, we can eliminate this answer.

Let’s turn to choice (E). Why wouldn’t it be adjusted? Poverty must be relative to the cost of living. If the cost of living doubled, then the numbers in poverty would increase greatly. But failure to adjust for the cost of living would miss that effect. Again, common sense leads us to eliminate this answer.

Next we can turn to choice (A). That doesn't work either, because everyone who pays into Social Security has a right to receive benefits when they grow old, regardless of whether they are rich or poor. “Social security” is not “security only if you’re poor.” We can eliminate this choice.

We’re left with only two possibilities: (B) and (D). Realize that has increased our odds of choosing the right answer to 50% now. If you took the CLEP and at least narrowed every difficult question down to two choices, then you would likely pass the test. How do we next make our best choice among these final two options?

Option (D) seems to have the right amount of detail, and fits the question well grammatically. In contrast, Option (B) does not fit the question as well or make as much sense (definition of what the poverty level is should not change based on distributing some benefits). Even if you had no idea between (B) and (D), (D) is a better fit. It’s our best guess. (D), indeed, is correct.

It helps to choose an answer that gives the most meaning to the purpose of the question. The purpose of this question is to ask about how poverty-level income is calculated. Answer (D) most directly furthers that goal. It makes for a good guess if you did not otherwise know. You won’t always be able to guess the right answers, but by increasing your chances you can significantly increase your overall score.

Let’s try one more CLEP-inspired question, this time relating to labor:

Question: Assume a perfectly competitive market for both inputs and output. If capital is fixed and the price for the output increases, then a firm in the short run will increase its production by which of the following ways:

(A) increase capital until P=MR (B) increase labor until the value of the marginal product for workers equals the wage rate (C) increase capital until its average product equals the price of the additional capital (D) increase labor until its marginal product equals the wage rate (E) increase labor until the ratio of the price of the output to labor's marginal product equals the wage rate

This type of question benefits from being reread. “Capital is fixed,” according to the question. So capital cannot be increased. Answers (A) and (C) can be eliminated that easily. Many students sometimes miss the obvious on economics exams. They fail to read and understand the question.

Only labor can be increased, which is possible under answers (B), (D) and (E). We've improved our odds of success to a 33% chance. Those are good odds on a difficult question like this. But we can improve our chances even more.

(B) and (D) look similar so let’s turn to (E) first. The “marginal product of labor” is the additional units (“product”) produced due to an additional unit of labor. Remember “MP”? The term does not include “revenue” or “price”, so it only gives you the quantity. We need to multiply that quantity by product price to obtain revenue, what the firm owner cares the most about. Choice (E) makes no sense by dividing terms that should be multiplied together. We can eliminate it.

Back to (B) and (D). The only difference between the two is the term “value of” in (B). Think about what “marginal product” is. It is a quantity, not a dollar amount. Yet we are comparing it to “wage rate,” which would be in dollars. We need to insert “value of” to convert a quantity into equivalent dollars. (B) is must be the correct choice because it compares dollars to dollars, while choice (D) does not.

The key to good test-taking, particularly on economics exams, is to make sure you fully understand each question before trying to answer it.

There are only two or three questions (out of nearly 100) on the CLEP exam that have biased answers. They concern regulation and efficiency. You can expect to see one or two CLEP questions where the correct answer is to support government regulation against pollution. The best way to think about pollution is in terms of its "negative externality," but the CLEP exam writers cast the issue in terms of an efficient use of resources. Under this view, pollution is inefficient because it results in inefficient harm to the environment. Laws against pollution supposedly increase efficiency by preventing harm to the "resource" of the environment. These regulations that prohibit pollution cause less output but supposedly ensure a more efficient use of environmental resources.

While most of us support a cleaner environment, efficiency is usually associated with greater output, not less output. Government regulations almost never improve efficiency; the free market does that best without government interference. That said, you can pick up one or two easy points on the CLEP exam by assuming that environmental regulation increases efficiency by protecting the "resource" of the environment for its better uses.

When companies are allowed to pollute without paying for it, their marginal cost (MC) is artificially lower than it should be. These companies are avoiding the cost of their own pollution. A lower MC means they will produce more goods than if their MC were higher. The term “marginal social cost” is used by economists to represent the true cost of their activities, including the cost of their pollution. Because companies produce more than they would if they had to pay for the cost of their pollution, some consider this to be inefficient. On the CLEP exam, it takes regulation to make it efficient by preventing the companies from putting out the pollution.

You might wonder what a conservative, free market approach to reducing negative externalities (like pollution) would be. One approach would be to require full disclosure to the public by companies of their negative externalities, so that the public could stop buying the product if the public was concerned about the negative externalities. That would enable the free market to solve the problem in an efficient way.

Outside the topic of government regulation on the CLEP exam, there are no biased answers. Do not choose one answer instead of another for reasons of bias except in one or two rare cases.

In areas unrelated to pollution, government establishes price floors, supports and ceilings. Do we all recall the differences? Price “ceilings” (or controls) are the easiest: the government says that the good cannot be sold for a higher price. Just as you cannot reach above your ceiling, the price is prohibited from rising above the ceiling that the government sets for it. It would be requiring gas to be sold for no more than $1.50, for example. The quantity supplied will decrease (move down the supply curve), while the quantity demanded will increase (move up the demand curve). Shortages result from price ceilings.

What is a price floor? Just the opposite of a ceiling. We cannot reach below the floor, and a price floor prevents the price from falling below a certain level. It would be a government law that prohibited milk from selling for less than $2 a gallon, for example. It would be intended to help the suppliers, such as dairy farmers. What happens when government imposes a price floor? There is a surplus of the good, as supply exceeds demand.

Now, how about a price support? That occurs when the government buys large quantities of good, such food, at prices higher than the competitive equilibrium. The government does this to “support” a higher price, instead of passing a law to require a higher price. A price support is designed to help the firms producing the goods, such as farmers. The rationale is that farmers are politically important and that pure competition is too brutal on their business and their lives, and also that foreign countries engage in the same practices. The effect of a “price support” is similar to a price floor: it creates a surplus of the good when the support is above the equilibrium price

When government regulates labor, the analysis is similar to its regulation of price. A “price floor” is created by the minimum wage: the buyer (an employer) must pay at least a certain amount for a service (labor). The minimum wage creates an oversupply of the service: too many workers. Not all of them will be able to obtain jobs at a wage higher than equilibrium. Unemployment results from a minimum wage that is higher than the equilibrium wage.

You have all learned a great deal of material in this course, information that will help you the rest of your lives. The insights and powerful concepts covered by this course can yield greater and greater benefits the more you think about them. Every week I see still something new and helpful in concepts taught in this course. Many students say that this is the best course they took from me, among other helpful courses. Use this course for your benefit.

If there is one unifying theme to this course, then I suggest it is summarized in Jesus's Parable of the Talents. Be productive, and God can multiply the benefits of your work. If you reach out, if you do more, if you make good use of your time, if you maximize your efficiency, if you consider the opportunity costs, and if you increase your output, then you give God more to work with. But if you bury your talents in the ground or if you are like the tree that does not bear fruit, then you give God less for His purpose.

Carpe diem. And be the good that drives out the bad as we discussed in connection with Gresham's Law.

Read this lecture and study for the final exam, which will be the first week in June. It will be 30 multiple-choice questions, similar in format to the quizzes.

? "Austrian economics" is an approach to economics that emphasizes the free markets, minimizing governmental interference, respecting private property rights, and promoting gold as a monetary standard. Beware, however, that Austrian economics organizations are often more libertarian than conservative on social issues, and Austrian economics itself has been slow in incorporating new economic insights such as the Coase theorem.? A price ceiling is a maximum price limitation, just as a real ceiling in a house limits the height. A perfectly competitive industry is already selling at its maximum output, so a price ceiling can't help there. But a monopoly increases its price by reducing its output. If a price ceiling is imposed against a monopoly, then it must reduce its price and increase its output, which benefits the public.

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Economics Lecture Thirteen

(Difference between revisions)== Review: Different Types of Markets ==== Review: Different Types of Markets ==You instructor wonders what topic will maximize our marginal utility next.  About 20% of the exam is devoted to questions about different types of markets, ranging from the most advantageous for the public (perfect competition) to the least advantageous for the public (monopoly).  That's a large chunk of questions, and with some extra review here we can probably potential convert wrong answers to right ones.You instructor wonders what topic will maximize our marginal utility next.  About 20% of the exam is devoted to questions about different types of markets, ranging from the most advantageous for the public (perfect competition) to the least advantageous for the public (monopoly).  That's a large chunk of questions, and with some extra review here students can convert potentially wrong answers into correct ones.The key to answering these questions correctly is to realize that the more competition there is, the lower the price of the goods and services and the lower the profits for the firms.  Some of these questions are special cases and should simply be memorized:  a cartel is an oligopoly that illegally agrees to fix (set) its prices, and an oligopoly is an industry where just a few firms dominate the market.  When given a grid about where an oligopoly ends up selling its goods (its Nash Equilibrium), the answer is always symmetric (all firms sell at the same price) and usually not the highest price that a monopoly could sell at.The key to answering these questions correctly is to realize that the more competition there is, the lower the price of the goods and services and the lower the profits for the firms.  Some of these questions are special cases and should simply be memorized:  a cartel is an oligopoly that illegally agrees to fix (set) its prices, and an oligopoly is an industry where just a few firms dominate the market.  When given a grid about where an oligopoly ends up selling its goods (its Nash Equilibrium), the answer is always symmetric (all firms sell at the same price) and usually not the highest price that a monopoly could sell at.There can be general questions about these markets.  A perfectly competitive market uses resources in a perfectly efficient way.  At the other end of the spectrum, a monopoly uses resources the least efficiently of all.  Its high pricing causes a huge social loss ("deadweight loss") by eliminating consumer surplus.  The monopoly reduces output in order to cause a scarcity that increases the price to an artificially high level.  This is bad for everyone, except the owner of the monopoly, who enriches himself.  This is how Bill Gates became the wealthiest person in the world.There can be general questions about these markets.  A perfectly competitive market uses resources in a perfectly efficient way.  At the other end of the spectrum, a monopoly uses resources the least efficiently of all.  Its high pricing causes a huge social loss ("deadweight loss") by eliminating consumer surplus.  The monopoly reduces output in order to cause a scarcity that increases the price to an artificially high level.  This is bad for everyone, except the owner of the monopoly, who enriches himself.  This is how Bill Gates became the wealthiest person in the world.Here is a puzzle to leave you with.  What is the impact on quantity of a price ceiling in a competitive industry compared to a price ceiling in a monopoly?  In which one (competitive v. monopoly) might a clever price ceiling actually increase quantity?  Think about it, and learn to ask yourself questions like this in order to master economics.  The answer is in this footnote.A price ceiling is a maximum price limitation, just as a real ceiling in house limits the height.  A perfectly competitive industry is already selling at its maximum output, so a price ceiling can't help there.  But a monopoly increases its price by reducing its output.  If a price ceiling is imposed against a monopoly, then it must reduce its price and increase its output, which benefits the public.Here is a puzzle to leave you with.  What is the impact on quantity of a price ceiling in a competitive industry compared to a price ceiling in a monopoly?  In which one (competitive v. monopoly) might a clever price ceiling actually increase quantity?  Think about it, and learn to ask yourself questions like this in order to master economics.  The answer is in this footnote.A price ceiling is a maximum price limitation, just as a real ceiling in a house limits the height.  A perfectly competitive industry is already selling at its maximum output, so a price ceiling can't help there.  But a monopoly increases its price by reducing its output.  If a price ceiling is imposed against a monopoly, then it must reduce its price and increase its output, which benefits the public.Be sure to spend time on the review sections in the prior lectures for more information about this and other topics on the exams.Be sure to spend time on the review sections in the prior lectures for more information about this and other topics on the exams.:(E) increase labor until the ratio of the price of the output to labor's marginal product equals the wage rate:(E) increase labor until the ratio of the price of the output to labor's marginal product equals the wage rateThis type of question benefits from being reread.  “Capital is fixed,” according to the question.  So capital cannot be increased.  Answers (A) and (C) can be eliminated that easily.  Many students miss the obvious sometimes on economics exams.  They fail to read and understand the question.This type of question benefits from being reread.  “Capital is fixed,” according to the question.  So capital cannot be increased.  Answers (A) and (C) can be eliminated that easily.  Many students sometimes miss the obvious on economics exams.  They fail to read and understand the question.Only labor can be increased, which is possible under answers (B), (D) and (E).  We've improved our odds of success to a 33% chance.  Those are good odds on a difficult question like this.  But we can improve our chances even more.Only labor can be increased, which is possible under answers (B), (D) and (E).  We've improved our odds of success to a 33% chance.  Those are good odds on a difficult question like this.  But we can improve our chances even more.

Economics Lectures - [1 - 2 - 3 - 4 - 5 - 6 - 7 - 8 - 9 - 10 - 11 - 12 - 13 - 14]

This lecture is the final review for this course, in preparation for the final exam. A student who took this class in 2007 sent me the following feedback from college:

My microeconomics class has been almost all review for me, because of the similar class I took from Mr. Andy Schlafly .... Although other students who attended public schools may have taken 'economics' before, they have struggled with microeconomics this semester, because their high school classes completely ignored the free-market and Austrian economics[1] which are taught [in college].

Let's begin this lecture by summarizing the percentages the CLEP exam devoted to particular topics. This will help organize the material we have covered in this course. Our online final exam next week will use a similar distribution in topics as the CLEP exam, but without over-emphasizing government policy as the CLEP exam does.

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Here is a list of the topics on the CLEP exam, along with how many questions are asked about each topic (as a percentage of the overall exam), plus tips about each concept:

cost measures (e.g., ATC, AFC, AVC) FC is total cost when output is zero; convert to average costs by dividing by output. Remember that ATC=AFC+AVC, and know when a firm should shut down. price ceilings cause shortages and taxes cause social (deadweight) loss; but beware of CLEP questions designed to make government regulation appear beneficial, as in reducing pollution Inputs to a Firm (espec. labor) key here is applying logic and other concepts to reason back from product demand to a firm's need for labor (workers); know effects of minimum wage laws; might also be asked about capital costs and profits and price are lowest for this type of market. P=MC=ATC and "economic profits" are squeezed to zero. If price falls, shut down in short run when PMC. P>ATC. what the public will pay; all firms in all kinds of markets are restrained by the Law of Demand marginal revenue is the increase in total revenue due to selling one more unit; profit maximized where MR=MC marginal cost, which equals price in perfect competition. For a monopoly P>MC but equals MR=MC know the difference between these and private goods: public goods cannot exclude people from using the good without paying for it. think of Wal-Mart for increasing returns to scale; think of a kitchen for decreasing returns to scale ("too many cooks spoil the broth") what someone was willing to pay above what the good actually cost nation with lower production costs should do what it does best only a few firms, like two gas stations at an intersection far away from any others; usually one Nash Equilibrium-type exam question P>MC for this market, which is "allocatively inefficient" (is not efficient in the allocation of resources); it takes perfect competition to drive P down to MC overall satisfaction; recall our problem about hiking and reading. Marginal utility is your next bit of utility. Indifference curve shows trade-off in utility. Comparing change in demand for one good due to change in price for a different good keep in mind that "economic costs" include opportunity costs in addition to actual out-of-pocket (accounting) costs think ketchup with French fries in the long run all costs are variable and can be minimized; short and long run mentioned in 20% of questions, to distinguish between quick changes and permanent ones two types: positive (music in an open-air park) and negative (pollution) when income goes up, demand for an inferior good or service goes down (e.g., demand for bankruptcy services) substitution and income effects increase in price means less demand because public uses substitutes (substitution effect of price increase) and becomes poorer (income effect of price increase) an oligopoly that illegally agrees to fix (set) prices, as OPEC does charging different prices for the exact same good; only possible if the market allows the firm to set its own price

Some important topics are missing from the CLEP exam, such as the invisible hand, free market, charity, transaction costs, the time value of money, interest rates, the Coase theorem and Gresham's Law. The reason is exam bias. For example, once a student realizes how inefficient transaction costs are, he or she will probably not like government regulations much! Instead of these concepts, the CLEP exam adds lots of questions about government regulation to try to make regulation look good. But other than bias in the selection of question, bias is rare in answers to economics questions. Pick the answer that you think is correct, without worrying about bias.

As always, be sure you fully understand the question before you answer it, and use common sense and logic. In fact, many economics questions can be answered correctly with patience and basic reasoning skills.

Let's put our knowledge from this course to good use in studying for our final exam, and preparing for the CLEP exam. We maximize our utility by scoring as high as possible on these exams. To do so, we need to maximize our marginal utility in allocating our time towards the exam topics listed above. If we spend all our studying time on "price discrimination," which is only 1% of the exam, then we are not maximizing our marginal utility and will not reach our full potential.

This is similar to our homework problem earlier in the course about maximizing our marginal utility with respect to hiking and reading. This time, however, the decision each student must make is which topic to focus on first in the above list, and how much time to spend on it before moving on to another topic in the list. The answer may be different for each student.

This same challenge in optimizing strategy could be expressed as a problem of "allocative efficency": allocating resources (time and information) in the most efficient way. Just as efficiency is essential to successful businesses, efficiency is also important to becoming a successful student. Spending your time efficiently in preparing for the final exam, and preparing for the CLEP, is crucial to your ability to do well on them. Look at the above list of topics and how often they appear, and ask yourself: where should you focus first in order to pick up the most points in the shortest amount of time?

Should you simply start reviewing at the top of the list and work your way down to the bottom? That strategy has the advantage of focusing on the most important topics first. If you run out of time in reviewing, then you will miss only the less important topics. But you might improve further on that strategy by moving more quickly through topics that you already understand well. Alternative, there may be topics that you find too difficult to understand, and you might give up some points there in order to focus better on topics where you can pick up more points.

For the rest of this class this lecture will focus on topics which might provide the greatest marginal increase in your exam scores. This takes into consideration the topics we have already reviewed (you have the materials for those), and avoids duplication of that review. You may, however, decide for yourself that you can benefit most from reviewing those prior topics.

Your instructor emphasizes studying strategy for a reason. The biggest reason why some students do not succeed is a lack of effort. But the second biggest reason is poor studying and test-taking strategies, like a football team that runs ill-advised plays. Education, like business and perhaps even life itself, rewards good strategies and punishes misguided ones.

For many students, the most additional points can be obtained by reviewing the "Inputs to a Firm" category. It will be on 10% of the questions on the final exam and the CLEP exam. That's a significant chunk of these exams. Without review, these questions look hard and are easy to miss. But with some extra preparation, you should be able to answer nearly all of them correctly. In maximizing your score and making the best use of your time, this category may result in the biggest increase in correct answers with the least amount of effort. That's what maximizing marginal utility is all about.

Accordingly, in economic terms, the greatest marginal utility from studying for the exam is probably obtaining by focusing on this topic first. We've already covered the other two topics comprising 10% apiece of the exam (cost measures and government regulation), so there may not be many more points to pick up there. Realize that you will probably get some exam questions right without additional studying, and other questions you may get wrong no matter how much you study. But in this category of "inputs to a firm," you can pick up some points that you would otherwise miss. Let's review it now.

Questions about inputs to a firm focus on what a firm will do with its inputs (typically labor, but sometimes capital) in order to maximize its profits. The questions usually concern the following:

impact of improvement in technology on the production by a firm adjusting inputs to minimize the overall cost at a constant level of output the effect of minimum wage on the competition for labor comparing the cost of an input (usually labor) relative to the additional revenue that results why a firm's "demand for labor" is called a "derived demand" what causes an increase in demand for labor the relation between hiring additional workers and the marginal cost calculating overall costs (total cost and average variable cost) based on wages

Review the above list now. How many of the above 8 topics do you know well enough to answer a question about them correctly? Let's briefly review each of these concepts so you can maximize your score on this big part of the exam.

1. "the impact of an improvement in technology on the production by a firm"

If technology improves, as in helpful new inventions or advances in communication (like the internet), then this helps shift the Production Possibilities Frontier (Curve) outward. A firm can produce more output now. So an improvement in technology enables a firm to increase its output or its supply to the market.

2. "adjusting inputs to minimize the overall cost at a constant level of output"

How does a firm adjust its inputs (e.g., workers or equipment) so that the firm reaches its lowest possible overall cost? By making sure that the firm is getting the most for each input. In other words, the firm makes sure that each input is producing the most marginal product per dollar spent on that input. If one worker is producing more than another worker, and both are being paid the same, then the owner has not lowered his costs to a minimum. He could fire the lazy worker and hire a part-time worker like his good one, and then produce the same output at less cost. Summarizing the above, a firm minimizes its overall costs by making sure the marginal product per cost for each input is equal. If one input (e.g., one worker) is producing more marginal product per cost than another, then the overall costs are not minimized. The unproductive worker is wasting the firm's money.

3. "the effect of the minimum wage on the competition for labor"

Increasing the minimum wage has the effect of increasing unemployment. Workers who have jobs make more money when the minimum wage is increased, but firms can afford to hire fewer people. The number of the unemployed (the people who cannot get jobs) increases when the minimum wage is increased. Also, although this will never be asked on a CLEP exam, raising the minimum wage causes more high school students to drop out and pursue jobs rather than stay in school, which would enable them to obtain higher-paying jobs in the future. Sometimes the CLEP exam will twist the question about minimum wage to obscure its harmful effect, by asking what happens when the labor supply increases when there already is a minimum wage. This makes it look like the fault is an increase in the labor supply rather than the minimum wage law. The correct answer is the same in both cases: unemployment increases.

4. "comparing the cost of an input (usually labor) relative to the additional revenue that results"

This type of question probes how a firm increases its inputs in relation to the additional revenue that results from such an increase. The key here is to be very careful and very logical. A firm will increase an input (such as labor) until the value of the marginal product of that input equals the marginal cost of that input. Read that sentence over and over until you understand it. It simply means that the firm will equate the marginal cost of the additional input (such as an additional worker) to the marginal revenue that the additional input produces. Often students miss this type of question because they are not careful to compare dollars to dollars. If you have the marginal cost in terms of dollars (such as a wage rage for the additional worker), then you need to equate it to the marginal value of the marginal product of the labor (value is in dollar units), not the marginal product itself (which is a unit quantity).

5. "why a firm's "demand for labor" is called a "derived demand"

This is an easy point to pick up on an exam. A firm's demand for an input (such as labor) is called a "derived demand" because it depends on the demand for the goods produced by that input. For example, a restaurant's demand for waitresses is entirely dependent on the public's demand to be served at the restaurant. If there is no public demand to be waited on at the restaurant, then the restaurant (the firm) has no demand for waitresses!

6. "what causes an increase in demand for labor"

This is another easy issue, similar to the prior one above. If the public demand for the product of the labor increases, then there is an increase in demand for the labor itself. If more people want to eat McDonald's hamburgers, then there is more demand for workers to make McDonald's hamburgers. How do we know when the demand by the public for the product of certain labor increases? When the price of the good or service produced by the labor increases. When that price goes up, then there is an increase in demand for the workers who make that good or service.

7. "the relation between hiring additional workers and the marginal cost"

This is a more challenging issue that requires two steps rather than one in order to answer correctly. Marginal cost is additional cost to a firm for making one more unit. It is measured in dollars, not in units. Making sure you have the right measure (dollars or units) for your answer will help you reduce mistakes. The answer for any question about marginal cost must be in dollars (or cents) per unit. Accordingly, if you are told how many additional units are produced by each additional worker, then calculating the marginal cost requires dividing the cost of the additional worker by the additional number of units he produces. The more units an additional worker produces, the lower the marginal cost that results from adding that worker. Example: suppose a firm hires Tom and sees the output increase by 20 units, and then hires Mary at the same wage and sees the output increase by 15 units. When is the marginal cost of the firm the lowest? After it hires Tom, but before it hires Mary. That's because the marginal cost of hiring Tom is his wages divided by 20, while the marginal cost of hiring Mary is the same wage divided by 15. A wage divided by 20 is less than the same wage divided by 15, so the marginal cost to the firm after hiring Tom is less than after hiring Mary.

8. "calculating overall costs (total cost and average variable cost) based on wages"

The key here is simply to be careful in doing the calculations, and then double-check your answer. You need to be sure you are using the correct level of output before you calculate the total cost (TC) and average variable cost (AVC) at that level of output. To find the total cost, add the fixed cost (FC) to the variable cost (the variable cost is usually the labor cost: total wages times the number of workers), for a given level of output. Then, to find the average variable cost, find the total variable cost (TVC=TC-FC) and divide by that level of output. Example: a firm can produce 100 units with 5 workers and 200 units with 10 workers. Its fixed cost is $50 and its wage rate is $20 per worker. What is its total cost and average variable cost to produce 100 units? Answer: notice first that the question asks about the costs at 100 units in output, not 200 units. Total cost at 100 units is the fixed cost ($50) plus the labor cost ($20 times 5 workers, or $100), for a total of $150. The average variable cost is the total cost ($150) minus the fixed cost ($50), divided by the output (100), for a total of $1 per unit.

Master the above eight issues, and you'll convert 10% of the exam from wrong answers to correct ones. That could enable you to earn college credit.

You instructor wonders what topic will maximize our marginal utility next. About 20% of the exam is devoted to questions about different types of markets, ranging from the most advantageous for the public (perfect competition) to the least advantageous for the public (monopoly). That's a large chunk of questions, and with some extra review here students can convert potentially wrong answers into correct ones.

The key to answering these questions correctly is to realize that the more competition there is, the lower the price of the goods and services and the lower the profits for the firms. Some of these questions are special cases and should simply be memorized: a cartel is an oligopoly that illegally agrees to fix (set) its prices, and an oligopoly is an industry where just a few firms dominate the market. When given a grid about where an oligopoly ends up selling its goods (its Nash Equilibrium), the answer is always symmetric (all firms sell at the same price) and usually not the highest price that a monopoly could sell at.

The monopoly questions look harder than they really are. The monopolist sets his price higher than marginal cost, which would be the optimal price from the standpoint of the public (or government). Instead, the monopolist price sets his price where marginal revenue equals marginal cost (MR=MC). If shown a graph, you may have to find the quantity where MR=MC, and then find the corresponding price on the demand curve. Notice that a monopolist has no supply curve, because a supply curve represents many firms in an industry and a monopolist is the only firm in the industry.

There can be general questions about these markets. A perfectly competitive market uses resources in a perfectly efficient way. At the other end of the spectrum, a monopoly uses resources the least efficiently of all. Its high pricing causes a huge social loss ("deadweight loss") by eliminating consumer surplus. The monopoly reduces output in order to cause a scarcity that increases the price to an artificially high level. This is bad for everyone, except the owner of the monopoly, who enriches himself. This is how Bill Gates became the wealthiest person in the world.

Here is a puzzle to leave you with. What is the impact on quantity of a price ceiling in a competitive industry compared to a price ceiling in a monopoly? In which one (competitive v. monopoly) might a clever price ceiling actually increase quantity? Think about it, and learn to ask yourself questions like this in order to master economics. The answer is in this footnote.[2]

Be sure to spend time on the review sections in the prior lectures for more information about this and other topics on the exams.

A public good is a good which is nonexcludable and nondepletable. The first condition means that it is impossible to exclude consumers from partaking in the good, and the second condition means that one consumer's consumption of the good does not prevent others from consuming it.

Explained another way, a public good is available to all such that consumption by one person does not reduce its availability to others. An example of a public good is national defense, as it protects everyone and its benefits to one person do not diminish its benefits to others.

Other examples of public goods are law enforcement (protection by the police), public fireworks, clear air, street lights, radio and television transmissions, lighthouses, and some inventions. Some of these examples, such as lighthouses, are contested as to whether they must be a public good, as it is possible to charge ships port fees to pay for them. Also, while radio and television transmissions are available to all to receive them, it does cost money to buy radios and television sets, so these are not truly public goods either.

Liberals like to emphasize the concept of public goods on exams in order to support the argument for more government. Under this view public goods represent market failure and the need for government services supported by taxes.

Good test-taking techniques are particularly important to doing well on an economics exam. Simple questions are often intentionally disguised as something more complicated. It is easy to become confused and misguided in analyzing economic issues. 99% of the public would say that we would be better off if Congress put a price ceiling or cap on gasoline at $1 a gallon. It takes a bit more thought to realize that massive shortages would result, and we would all have to waste hours each week waiting in line for gasoline. Some who really need gas in hurry, such as people trying to take someone to a hospital, may not be able to obtain gas in time.

The ability to eliminate wrong answers can help. Let’s try the elimination technique on these questions:

Question: Consider the poverty-level of income for a family of four in America. Which of the following can be said about how the government defines this specific income level?

(A) It helps determine who is eligible for Social Security benefits. (B) It decreases when there is an increase in welfare benefits. (C) It proves that 50% of Americans live in poverty. (D) It is determined by tripling the cost of a nutritionally adequate diet by three. (E) Government does not adjust this number due to changes in the cost of living (inflation).

Virtually none of you would know the answer to this question at first glance. This question is not really appropriate for a "micro"-economics exam ("micro"-economics concerns individual buying and selling decisions), but CLEP asks it anyway. Questions about poverty, gaps between the rich and poor, and government programs are always favorites among liberal educators. You will see many more questions about these issues than about the invisible hand or the creation of wealth.

So what do we do when faced with this question? Simply give up? Move to the next question and hope it is easier? Blindly guess at an answer? None of the above.

We can narrow the choices, and thereby reduce our risk of error, by eliminating wrong answers. Basic economic principles (or common sense) serve as our guide.

Let’s start with choice (C). Think about it: is half of our nation living in poverty? What would that mean for elections? Who would pay to run government? If we called half of us "poor", then what word would be use for the really poor? Choice (C) can't be true. Using common sense, we can eliminate this answer.

Let’s turn to choice (E). Why wouldn’t it be adjusted? Poverty must be relative to the cost of living. If the cost of living doubled, then the numbers in poverty would increase greatly. But failure to adjust for the cost of living would miss that effect. Again, common sense leads us to eliminate this answer.

Next we can turn to choice (A). That doesn't work either, because everyone who pays into Social Security has a right to receive benefits when they grow old, regardless of whether they are rich or poor. “Social security” is not “security only if you’re poor.” We can eliminate this choice.

We’re left with only two possibilities: (B) and (D). Realize that has increased our odds of choosing the right answer to 50% now. If you took the CLEP and at least narrowed every difficult question down to two choices, then you would likely pass the test. How do we next make our best choice among these final two options?

Option (D) seems to have the right amount of detail, and fits the question well grammatically. In contrast, Option (B) does not fit the question as well or make as much sense (definition of what the poverty level is should not change based on distributing some benefits). Even if you had no idea between (B) and (D), (D) is a better fit. It’s our best guess. (D), indeed, is correct.

It helps to choose an answer that gives the most meaning to the purpose of the question. The purpose of this question is to ask about how poverty-level income is calculated. Answer (D) most directly furthers that goal. It makes for a good guess if you did not otherwise know. You won’t always be able to guess the right answers, but by increasing your chances you can significantly increase your overall score.

Let’s try one more CLEP-inspired question, this time relating to labor:

Question: Assume a perfectly competitive market for both inputs and output. If capital is fixed and the price for the output increases, then a firm in the short run will increase its production by which of the following ways:

(A) increase capital until P=MR (B) increase labor until the value of the marginal product for workers equals the wage rate (C) increase capital until its average product equals the price of the additional capital (D) increase labor until its marginal product equals the wage rate (E) increase labor until the ratio of the price of the output to labor's marginal product equals the wage rate

This type of question benefits from being reread. “Capital is fixed,” according to the question. So capital cannot be increased. Answers (A) and (C) can be eliminated that easily. Many students sometimes miss the obvious on economics exams. They fail to read and understand the question.

Only labor can be increased, which is possible under answers (B), (D) and (E). We've improved our odds of success to a 33% chance. Those are good odds on a difficult question like this. But we can improve our chances even more.

(B) and (D) look similar so let’s turn to (E) first. The “marginal product of labor” is the additional units (“product”) produced due to an additional unit of labor. Remember “MP”? The term does not include “revenue” or “price”, so it only gives you the quantity. We need to multiply that quantity by product price to obtain revenue, what the firm owner cares the most about. Choice (E) makes no sense by dividing terms that should be multiplied together. We can eliminate it.

Back to (B) and (D). The only difference between the two is the term “value of” in (B). Think about what “marginal product” is. It is a quantity, not a dollar amount. Yet we are comparing it to “wage rate,” which would be in dollars. We need to insert “value of” to convert a quantity into equivalent dollars. (B) is must be the correct choice because it compares dollars to dollars, while choice (D) does not.

The key to good test-taking, particularly on economics exams, is to make sure you fully understand each question before trying to answer it.

There are only two or three questions (out of nearly 100) on the CLEP exam that have biased answers. They concern regulation and efficiency. You can expect to see one or two CLEP questions where the correct answer is to support government regulation against pollution. The best way to think about pollution is in terms of its "negative externality," but the CLEP exam writers cast the issue in terms of an efficient use of resources. Under this view, pollution is inefficient because it results in inefficient harm to the environment. Laws against pollution supposedly increase efficiency by preventing harm to the "resource" of the environment. These regulations that prohibit pollution cause less output but supposedly ensure a more efficient use of environmental resources.

While most of us support a cleaner environment, efficiency is usually associated with greater output, not less output. Government regulations almost never improve efficiency; the free market does that best without government interference. That said, you can pick up one or two easy points on the CLEP exam by assuming that environmental regulation increases efficiency by protecting the "resource" of the environment for its better uses.

When companies are allowed to pollute without paying for it, their marginal cost (MC) is artificially lower than it should be. These companies are avoiding the cost of their own pollution. A lower MC means they will produce more goods than if their MC were higher. The term “marginal social cost” is used by economists to represent the true cost of their activities, including the cost of their pollution. Because companies produce more than they would if they had to pay for the cost of their pollution, some consider this to be inefficient. On the CLEP exam, it takes regulation to make it efficient by preventing the companies from putting out the pollution.

You might wonder what a conservative, free market approach to reducing negative externalities (like pollution) would be. One approach would be to require full disclosure to the public by companies of their negative externalities, so that the public could stop buying the product if the public was concerned about the negative externalities. That would enable the free market to solve the problem in an efficient way.

Outside the topic of government regulation on the CLEP exam, there are no biased answers. Do not choose one answer instead of another for reasons of bias except in one or two rare cases.

In areas unrelated to pollution, government establishes price floors, supports and ceilings. Do we all recall the differences? Price “ceilings” (or controls) are the easiest: the government says that the good cannot be sold for a higher price. Just as you cannot reach above your ceiling, the price is prohibited from rising above the ceiling that the government sets for it. It would be requiring gas to be sold for no more than $1.50, for example. The quantity supplied will decrease (move down the supply curve), while the quantity demanded will increase (move up the demand curve). Shortages result from price ceilings.

What is a price floor? Just the opposite of a ceiling. We cannot reach below the floor, and a price floor prevents the price from falling below a certain level. It would be a government law that prohibited milk from selling for less than $2 a gallon, for example. It would be intended to help the suppliers, such as dairy farmers. What happens when government imposes a price floor? There is a surplus of the good, as supply exceeds demand.

Now, how about a price support? That occurs when the government buys large quantities of good, such food, at prices higher than the competitive equilibrium. The government does this to “support” a higher price, instead of passing a law to require a higher price. A price support is designed to help the firms producing the goods, such as farmers. The rationale is that farmers are politically important and that pure competition is too brutal on their business and their lives, and also that foreign countries engage in the same practices. The effect of a “price support” is similar to a price floor: it creates a surplus of the good when the support is above the equilibrium price

When government regulates labor, the analysis is similar to its regulation of price. A “price floor” is created by the minimum wage: the buyer (an employer) must pay at least a certain amount for a service (labor). The minimum wage creates an oversupply of the service: too many workers. Not all of them will be able to obtain jobs at a wage higher than equilibrium. Unemployment results from a minimum wage that is higher than the equilibrium wage.

You have all learned a great deal of material in this course, information that will help you the rest of your lives. The insights and powerful concepts covered by this course can yield greater and greater benefits the more you think about them. Every week I see still something new and helpful in concepts taught in this course. Many students say that this is the best course they took from me, among other helpful courses. Use this course for your benefit.

If there is one unifying theme to this course, then I suggest it is summarized in Jesus's Parable of the Talents. Be productive, and God can multiply the benefits of your work. If you reach out, if you do more, if you make good use of your time, if you maximize your efficiency, if you consider the opportunity costs, and if you increase your output, then you give God more to work with. But if you bury your talents in the ground or if you are like the tree that does not bear fruit, then you give God less for His purpose.

Carpe diem. And be the good that drives out the bad as we discussed in connection with Gresham's Law.

Read this lecture and study for the final exam, which will be the first week in June. It will be 30 multiple-choice questions, similar in format to the quizzes.

? "Austrian economics" is an approach to economics that emphasizes the free markets, minimizing governmental interference, respecting private property rights, and promoting gold as a monetary standard. Beware, however, that Austrian economics organizations are often more libertarian than conservative on social issues, and Austrian economics itself has been slow in incorporating new economic insights such as the Coase theorem.? A price ceiling is a maximum price limitation, just as a real ceiling in a house limits the height. A perfectly competitive industry is already selling at its maximum output, so a price ceiling can't help there. But a monopoly increases its price by reducing its output. If a price ceiling is imposed against a monopoly, then it must reduce its price and increase its output, which benefits the public.

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