WGU C211 Study Guide with Complete Solutions

Consumer Surplus - ANSWER-The benefit from trade. It is the difference between the price paid and the Willingness To Pay. Who receives consumer surplus? - ANSWER-The Consumer In relation to the demand curve and price, how is consumer surplus measured? - ANSWER-Consumer surplus is found above the price and below the demand curve. Producer Surplus - ANSWER-The benefit from trade to the producer. It is equal to the difference between the marginal cost of production and the price. Producer Surplus - ANSWER-The Producer In relation to the supply curve and price, how is producer surplus measured? - ANSWER-Below equilibrium price and above supply How is total surplus determined? - ANSWER-Total Surplus = Consumer Surplus + Producer Surplus In what ways might government or policy makers make use of surplus measures? - ANSWER-Measuring surplus to judge the effefctiveness of policy. Microeconomics - ANSWER-Focuses on individual households, consumers, markets, and industries. Macroeconomics - ANSWER-Focuses on the larger economic picture including unemployment, interest rates, and GDP. Why must income equal expenditure in an economy as a whole? - ANSWER-Because every seller has a buyer. Define Gross Domestic Product (GDP). What does it measure? - ANSWER-Gross Domestic Product is the final value of all goods and services produced within a country within a period of time (usually a year). Four components of GDP: - ANSWER-C = Consumption I = Investment G = Government Spending NX = Exports - Imports Aggregate Demand (GDP 4 Components) - ANSWER-Aggregate Demand = C + I + G + NX Why are transfer payments such as social security not counted in government expenditures? - ANSWER-Transfer payments are not used in the purchase of goods or services and thus do not add to Aggregate Demand directly. The money, when transferred, will be used by the recipient in either the consumption of investment categories. Real GDP - ANSWER-Current year production at base year prices. Nominal GDP - ANSWER-Current year production and current year prices. Tariff - ANSWER-A tax on imported goods Dead Weight Loss - ANSWER-The loss of total surplus caused by inefficiencies in the market. Things like taxes/tariffs/monopoly power/etc. How are tariff's and dead weight loss related? - ANSWER-When the market is affected by a tariff, this artificially increases the equilibrium price and thus creates losses as a result. Those who would have exchanged at the previous equilibrium price will no longer (or at least some portion) and as a result there is a loss of the mutually beneficial exchange that results in a loss of total surplus. Two primary categories of trade barriers: - ANSWER-Tariffs and Non-Tariff Barriers If an import tariff is imposed on coconuts that are imported into the U.S., how will this impact the price of coconuts for U.S. consumers? - ANSWER-When a Tariff is imposed, the price increases. Why might a government be interested in imposed an import tariff on a good? What benefit would the government drive primarily? - ANSWER-Governments often impose tariffs in order to protect infant industry for national benefit. How would imposing an import tariff on cigars impact the domestic production of cigars? - ANSWER-Due to the higher price of imports (world price + tariff) relatively inefficient domestic producers will now be able to compete and thus domestic production will increase. If an import tariff on coconuts was removed in the US, how would this impact the demand for coconuts by US consumers? - ANSWER-A removal of an import tariff would result in a lowering of the market price domestically, and this would increase quantity demanded for the good. What would happen to the overall domestic demand for a good if an import tariff were imposed on that good? - ANSWER-Imposing an import tariff would increase the market price and thus decrease domestic demand for the good. How does a tariff generally impact the consumers? - ANSWER-Domestic Consumers: Reduced demand and higher prices (loss of consumer surplus) How does a tariff generally impact the producers? - ANSWER-Domestic Producers: Increase production/sales (increase in producer surplus) How does a tariff generally impact the Government? - ANSWER-Governments: Get tax revenue Explain the effect an income change might have on shifting the demand curve? - ANSWER--- If the good is a normal good, an increase in income will shift the demand curve to the right; a decrease in income will shift the demand curve to the left. -- If the good is an inferior good, an increase in income will shift the demand curve to the left; a decrease in income will shift the demand curve to the right. Normal Good - ANSWER-Normal goods see their demand increase when income increases. Inferior Good - ANSWER-Inferior goods see their demand fall when incomes increase. How price of related goods is related to changes in the demand curve: - ANSWER--- When two goods are substitutes for each other in consumption, the increase in the price of one will lead to an increase in the demand for the other as consumers substitute into the now cheaper good. -- When two goods are complements for each other in consumption, the increase in the price for one will lead to a decrease in the price for the other as consumers forgo consumption of one there is no need for the other as they are always consumed together. If Luke and I are the only sellers of paper in a given market, and Luke drops his prices for paper, how will this impact the demand for my paper? Which way will the demand curve shift? - ANSWER-Because Luke's paper and my paper are substitutes, a decrease in the price of Luke's paper will cause a decrease in the demand for my paper as customers substitute into Luke's paper. Factors that might influence the position of the demand curve: - ANSWER-- Income - Price of Related Goods - Number of Buyers - Tastes & Preferences - Expectations What numerical value determines whether or not a product/service is considered price elastic versus inelastic? - ANSWER-The Price Elasticity of Demand being greater than or less than 1 Income Elasticity - ANSWER-Income Elasticity of Demand: A measure of the responsiveness of demand to changes in consumer income. Price Elasticity of Demand - ANSWER-Measures the responsiveness of quantity demanded to changes in price. Elastic: - ANSWER-When the price elasticity of demand is greater than 1, this suggests that consumers are sensitive to changes in price, and have many substitutes that they can replace the now more expensive good with easily. Inelastic: - ANSWER-When the Price Elasticity of Demand is less than 1, this suggests that consumers maintain consumption levels (quantity) even as price fluctuates. This tends to be necessity goods like electricity, gas, milk, diapers, etc. Unit Elastic: - ANSWER-When the Price Elasticity of Demand is exactly equal to 1. This occurs at price/quantity where Total Revenue has been maximized. What two results stem from income elasticity? Why is this important to an economist? - ANSWER-Normal goods have positive income elasticity of demand value and inferior goods have a negative income elasticity of demand value. Cross-Price Elasticity - ANSWER-Cross-Price Elasticity measures the responsiveness of one good to price changes in another. Results: Substitution goods have positive cross-price elasticity of demand and complements have a negative cross-price elasticity of demand. In the net, how are price (P) and quantity (Q) changed by simultaneous increase in demand and supply? - ANSWER-Price is ambiguous; Quantity rises In the net, how are price (P) and quantity (Q) changed by a simultaneous increase in demand and decrease in supply? - ANSWER-Price rises; Quantity is ambiguous In the net, how are price (P) and quantity (Q) changed by a simultaneous decrease in demand and supply? - ANSWER-Price ambiguous; Quantity falls In the net, how are price (P) and quantity (Q) changed by a simultaneous decrease in demand and increase in supply? - ANSWER-Price increases; Quantity is ambiguous What tools does the Federal Reserve have with regards to monetary control? - ANSWER-- Reserve Requirement Ratio (RRR) - The Discount Window Rate - The Open Market Operations (OMC) What are open market operations? - ANSWER-The Open Market Committee (OMC) buys and sells government treasuries (bonds) in the open market. This is the definition of Open Market Operations. When the Fed buys bonds, what impact does this have on the money supply and aggregate demand? - ANSWER-When the Fed buys bonds, they exchange money into private hands (firms, individuals, and companies) and take the government treasuries out of the economy. ** This in turn increases the money supply -- increasing the money supply decreases market interest rates -- decreasing market interest rates increase investment spending -- increasing investment spending increases aggregate demand ** When the Fed sells bonds, what impact does this have on the money supply and aggregate demand? - ANSWER-When the Fed sells bonds, they exchange bonds into private hands (firms, individuals, and companies) and take the money out of the economy. ** This in turn decreases the money supply -- decreasing the money supply increases market interest rates -- increasing market interest rates decreases investment spending -- decreasing investments spending decreases aggregate demand ** What is a discount rate? - ANSWER-The Discount Window Rate is the interest rate that The Fed charges member banks when member banks borrow money from The Fed. When the Fed reduces the discount rate, what impact will this have on the money supply and the aggregate demand? - ANSWER-When the Fed reduces the Discount Rate banks are more willing to take risks with increased lending. This is because the cost of having to borrow from The Fed should their increased lending cause the bank to need to cover losses, is lower. ** Thus increased lending by banks increases the money supply -- increasing the money supply decreases market interest rates -- decreasing market interest rates increase investment spending -- increasing investment spending increases aggregate demand ** When the Fed increases the discount rate, what impact will this have on the money supply and the aggregate demand? - ANSWER-When the Fed increases the Discount Rate banks are less willing to take risks with increased lending. This is because the cost of having to borrow from The Fed should their increased lending cause the bank to need to cover losses, is higher. ** Thus decreased lending by banks decreases the money supply -- decreasing the money supply increases market interest rates -- increasing market interest rates increase investment spending -- decreasing investment spending decreases aggregate demand ** Reserve Ratio - ANSWER-The Reserve Requirement Ratio (RRR) is the proportion of deposits that member banks are required to hold as reserves at The Fed. Ex: If I deposit $100 at my bank and The Fed has a RRR of 20% they will hold on to $20 in their reserves at The Fed, and the member bank will be allowed to lend out the rest. What would the Fed need to do with the reserve ratio in order to increase the money supply and aggregate demand in the economy? - ANSWER-Lower it What would the Fed need to do with the reserve ratio in order to decrease the money supply and aggregate demand in the economy? - ANSWER-Raise it If the Fed uses monetary policy in a way that increases money supply, what effect will this have on interest rates and aggregate demand (consider them separately)? - ANSWER-increases in the money supply decreases market interest rates -- decreasing market interest rates increase investment spending -- increasing investment spending increases aggregate demand If the government uses fiscal policy to increase government spending what impact will this have on interest rates and aggregate demand? - ANSWER-When congress increases gov spending, this increases aggregate demand directly. When aggregate demand increases people's incomes also increase. This increase in income causes money demand to increase and thus pushes up the market interest rate. At the new higher market interest rate investment falls somewhat, causing a decrease in aggregate demand; this is a secondary accidental effect called the "Crowding-Out Effect". If the gov uses fiscal policy and cuts taxes, what effect will this have on interest rates and aggregate demand? - ANSWER-When congress cuts taxes for citizens, this increases people's disposable income and thus their consumption. This increases aggregate demand. When aggregate demand increases peoples incomes also increase. This increase in income causes money demand to increase and thus pushes up the market interest rate. At the new higher market interest rate investment falls somewhat, causing a decrease in aggregate demand; this is a secondary accidental effect called the "Crowding-Out Effect". How is marginal cost derived? - ANSWER-By measuring the addition to total cost which results from a one-unit change in production. How is marginal cost related to total cost? - ANSWER-Marginal cost measures how total cost changes as production levels change.