FSU ECO 3101 EXAM 1 Questions with Complete Answers.

FSU ECO 3101 EXAM 1 Questions with Complete Answers Why does a price ceiling prevent the market from reaching equilibrium prices and quantities? - Correct Answers: Price ceilings are enacted in an attempt to keep prices low for those who need the product. However, when the market price is not allowed to rise to the equilibrium level, quantity demanded exceeds quantity supplied, and thus a shortage occurs. Why does a price floor prevent the market from reaching equilibrium prices and quantities? - Correct Answers: Price floors prevent a price from falling below a certain level. When a price floor is set below the equilibrium price, quantity supplied will exceed quantity demanded, and excess supply or surpluses will result. If price elasticity of demand = 0, - Correct Answers: demand is perfectly inelastic -- Q does not change at all when price changes (vertical demand curve) Ex) essential goods If price elasticity of demand is 1, - Correct Answers: demand is inelastic -- demand is relatively unresponsive to a price change If price elasticity of demand = 1, - Correct Answers: demand is unit elastic -- % change in demand is the same as % change in price If price elasticity of demand 1, - Correct Answers: demand is elastic -- demand is responsive to a price change If price elasticity of demand is infinite, - Correct Answers: demand is perfectly elastic -- if price increases even slightly, D=0 If price elasticity of supply = 0, - Correct Answers: supply is perfectly inelastic -- does not respond to change in demand (perfectly vertical) If price elasticity of supply 1, - Correct Answers: supply is inelastic -- supply is relatively unresponsive to change in demand If price elasticity of supply is infinite, - Correct Answers: supply is perfectly elastic -- change in demand does not change price (perfectly horizontal) If price elasticity of supply 1, - Correct Answers: supply is elastic -- supply is relatively responsive to change in demand What are the assumptions of the supply and demand model? - Correct Answers: S&D helps us make predictions about perfectly competitive markets and when all firms and consumers are price takers. When is it appropriate to use a supply and demand model? - Correct Answers: 1) many buyers and sellers 2) identical products 3) all market agents have full information 4) transaction costs are negligible 5) firms can easily enter and exit When is it NOT appropriate to use a supply and demand model? - Correct Answers: 1) monopoly/monopsony 2) differentiated goods 3) asymmetrical information 4) transportation is not free 5) new firms cannot enter easily or face threats What are the properties of a rational consumer's preferences? - Correct Answers: 1) complete -- when facing 2 bundles {a, b}, a consumer can rank them so that a}b, b}a, or a~b 2) transitivity -- consumer preferences are logically consistent 3) monotonicity (more is better) -- all else equal, more of a good is preferred What are the properties of indifference curves? - Correct Answers: -have a negative slope (willing to give up some to get more of other goods) -further from the origin (0,0), preferred (the more, the better) -convex toward 0 (decreasing marginal utility -Indifference curves cannot cross What other factors might drive demand, but are not captured in the demand curves from class? - Correct Answers: Price, income of consumers, prices of related goods, preferences of consumers, externalities Price Consumption Curve (PCC) - Correct Answers: relates consumer's utility to their demand curve -- PCC slopes up because utility is higher when more can be consumed (more is better) Engel Curve - Correct Answers: the relationship between the quantity demanded of a single good and income, holding prices constant How is the shape of the Engel curve determined by the income elasticity of demand? (if goods are normal or inferior) - Correct Answers: If EI is 0, the good is normal If EI is 0, the good is inferior *refer to last page of notes How does a change in income relate to a change in price? - Correct Answers: A price increase shrinks the opportunity set -- effectively reduces income How does a change in the price of one good change the total opportunity set? - Correct Answers: Changing the price of 1 good changes the relative price of the other good How do you know if a consumer chooses optimally? - Correct Answers: MRS (slope of IC) = MRT (slope of BC) MUx/Px = MUy/Py The budget line is tangent to the indifference curve at the bundle chosen Cross Price Elasticity - Correct Answers: How responsive consumers are to price change If cross price elasticity 0, goods are substitutes If cross price elasticity 0, goods are complements What is the formula for finding elasticity? - Correct Answers: E = %ΔQ/%ΔP = ΔQ/ΔP * P/Q = dQ/dP * P/Q If two goods are perfect substitutes, then the indifference curves for those two goods would be - Correct Answers: Downward sloping and straight If two goods are perfect complements, then the indifference curves for those two goods would be - Correct Answers: L-shaped Utility - Correct Answers: Set of numbers that reflect the relative rankings of bundles of goods