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ECO 211: Introductory Microeconomics

Review Sheet—Exam 1
Fall 2007

Exam will cover material in text chapters 1through 6. The exam will have both multiple-choice
questions and “essay” and/or “problem-solving” questions. You should be familiar with Krugman’s
essays, “The Accidental Theorist” and “In Praise of Cheap Labor.” You will not need to know
these articles I detail. But you should know what the topic of each essay is and what point(s)
Krugman is making.

I. Introduction

A lot of economic jargon was introduced at the beginning of the course; e.g., efficiency, equity,
scarcity, opportunity cost, normative and positive analysis, comparative advantage, etc., etc.
While you will not be asked to give exact definitions for these terms, you should know what they
mean and understand their importance.

You should be familiar with the methodology of economic analysis (“scientific method”) and the
value of model-building.

You should be able to work with Production Possibilities Frontiers: Know what they represent,
how efficiency, inefficiency and growth can be demonstrated with a PPF. Be able to explain why
the slope of the PPF represents opportunity costs. Be able to explain what a “bowed-out” frontier
represents (increasing costs).

II. Comparative Advantage

An important principle of economics is that there are Gains to Trade. Chapter 3 introduces one of
the most fundamental ideas in economics which highlights one source of gains to trade (Usually
referred to as the “Law of Comparative Advantage” or the “Principle of Comparative Advantage):
individuals (and/or countries) should specialize in the production of the good in which they have
the comparative advantage and trade for other goods.

 Be prepared to identify absolute advantage when provided with productivity information.

 Be prepared to calculate opportunity costs and identify comparative advantage given the
same information.

 Be able to create (graph) a Production Possibilities Frontier (PPF) and interpret it.

 Be able to use information opportunity costs to discuss patterns of trade (who trades what)
and to discuss at what prices trade can take place.
III. Supply and Demand (Chapter 4)

Know the definitions of Supply and Demand.

Know the determinants of supply and demand (the factors that can shift a supply or demand
curve).

Be able to find the market equilibrium in a supply and demand graph and be able to explain why
this is an equilibrium.

Be able to perform “comparative-statics” exercises using supply and demand analysis. You should
be able to do this type of analysis both verbally and graphically.

Here is a table listing the effects of changes in supply and demand on equilibrium price and
quantity:

DEMAND
No Change in Increase in Decrease in
S Demand Demand Demand
U No Change in Price ↑ Price ↓
P Supply Quantity↑ Quantity ↓
P Increase in Price ↓ Price ?? Price ↓
L Supply Quantity ↑ Quantity ↑ Quantity ??
Y Decrease in Price ↑ Price ↑ Price ??
Supply Quantity ↓ Quantity ?? Quantity ↓

Your textbook suggests a 3-step procedure (page 78) that may be useful for correctly performing
these types of exercises:

1. Decide whether the event shifts the supply or demand curve (or perhaps both)
2. Decide which direction the curve(s) shift.
3. Use a supply and demand diagram to see how the shift(s) change equilibrium price and
quantity.

IV. Elasticity

You should know what elasticity is: a measure of responsiveness. More formally, you should know
the definition of Price Elasticity of Demand:

%∆Q D
ED =
%∆P

You should know categories of Elasticity:

• Relatively Elastic: ED > 1


• Relatively Inelastic: ED < 1
• Unit Elastic: ED = 1
You should know the relationship between Elasticity and Total Revenue:

• When demand is elastic, raising price will lower total revenue, lowering price will increase
total revenue.
• When demand is inelastic raising price will increase total revenue, lower price will
decrease total revenue.

You should also be able to explain why these relationships hold.

You should be able to use and discuss the determinants of price elasticity of demand.
• Availability of substitutes
• Percent of total budget spent on the good.
• Time frame

You should be familiar with the idea of price elasticity of supply

You should be familiar with other types of elasticity:

% ∆Q D
Income Elasticity of Demand: E D =
% ∆I

You should know that Normal Goods have positive income elasticity and Inferior Goods have
negative income elasticity.

% ∆Q D
x
Cross-Price Elasticity: E D = (The percentage change in demand for good x caused by a
% ∆Py
1% change in the price of good y)

You should know that Complements have negative cross-price elasticity and Substitutes have
positive cross-price elasticity.

V. Taxes and Price Controls

• You should know what a Price Ceiling is and what a Price Floor is. You should know what it
means for these to be “effective” price controls.
• Be able to explain the impact of price controls on market outcomes. For example, effective price
ceilings cause shortages and effective price floors cause surpluses.
• You should be able to give examples of each type of price control and be able to discuss the
“winners and losers” from such policies.
• Be able to analyze the effect of an excise tax on equilibrium.
• Know that the economic incidence of the tax is independent of the legal incidence.
• Know who pays the tax and how the burden is determined (determined by the elasticities of
supply and demand).
• Be able to show the impact of a tax and the distribution of the tax burden on a supply and
demand graph.