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Not only does a free market eliminate surpluses and shortages, a free market allocates production to the lowest cost producers and allocates consumption to the buyers who value the goods most highly. The producers willing to produce at the market price are the ones whose cost of production is equal to or less than the market price. The consumers who are willing to buy at the market price are the ones who value the goods as much as or more than the market price Free Markets and Economic Efficiency I A free market generally results in the most efficient quantity of output. We saw in Chapter 1 that any activity should be continued as long as the marginal benefit of the activity exceeds the marginal cost. The optimal (ideal, most efficient) level of the activity occurs where the marginal benefit and the marginal cost are equal. In a competitive product market, the marginal benefit of the product is indicated by the price that the marginal consumer is willing to pay. The price that the marginal consumer is willing to pay is indicated by the demand curve. The marginal cost of producing the product is indicated by the supply curve. Where the demand curve and the supply curve intersect (equilibrium) is the quantity where the marginal benefit of the product equals the marginal cost of the product. Thus, a free market generally produces the optimal (ideal, most efficient) quantity of output. Free Markets and Economic Efficiency II We saw in Chapter 2 that the net benefit to society of having a market available for trading is the sum of the consumer’s surplus and the producer’s surplus received by all the buyers and sellers in the market. Consumer’s surplus is the difference between the highest price a buyer is willing to pay and the price actually paid. For all the buyers in a market, consumer’s surplus is indicated by the area below the demand curve and above the market price. Producer’s surplus is the difference between the lowest price a seller is willing to accept and the price actually received. For all the sellers in a market, producer’s surplus is indicated by the area above the supply curve and below the market price. In a free market, the quantity produced (equilibrium quantity) is the quantity that maximizes the net benefit to society of having the market available for trading (i.e. maximizes the sum of the consumer’s surplus and the producer’s surplus received by all the buyers and sellers in the market). Example 12: The graph below indicates the consumer’s surplus and the producer’s surplus in the market for Good X (from Example 11). $7 - S 6 - Consumer’s 5 - Surplus Price 4 - Producer’s 3 - Surplus 2 - 1 - 0 D 0 5 10 15 20 25 30 35 40 FOR REVIEW ONLY - NOT FOR DISTRIBUTION Quantity 3 - 7 Demand, Supply, and Equilibrium
A Change in Equilibrium Price and Quantity A change in demand or supply will result in a new equilibrium price and quantity. The table below shows the four possible changes and the effect of each change on equilibrium price and quantity. Change Price Quantity Demand increases Increases Increases Demand decreases Decreases Decreases Supply increases Decreases Increases Supply decreases Increases Decreases Example 13: The table and the graph below illustrate an increase in demand (D 2 ) and a decrease in demand (D 3 ). Market for Good X Quantity Original Quantity Increased Quantity Decreased Quantity Price Supplied Demanded (D 1 ) Demanded (D 2 ) Demanded (D 3 ) $7 30 0 10 0 6 25 5 15 0 5 20 10 20 0 4 15 15 25 5 3 10 20 30 10 2 5 25 35 15 1 0 30 40 20 $7 - S 6 - 5 - Price 4 - 3 - 2 - 1 - 0 D 3 D 1 D 2 0 5 10 15 20 25 30 35 40 Quantity Example 14: The table below and the graph on the next page illustrate an increase in supply (S 2 ) and a decrease in supply (S 3 ). Market for Good X Quantity Original Quantity Increased Quantity Decreased Quantity Price Demanded Supplied (S 1 ) Supplied (S 2 ) Supplied (S 3 ) $1 30 0 10 0 2 25 5 15 0 3 20 10 20 0 4 15 15 25 5 5 10 20 30 10 6 5 25 35 15 7 0 30 40 20 FOR REVIEW ONLY - NOT FOR DISTRIBUTION Demand, Supply, and Equilibrium 3 - 8
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PRINCIPLES OF ECONOMICS JEFF HOLT S
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Principles of Economics, 6th Editio
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16. Study Guide for Chapter 7 17. C
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11. Appendix: Book Review - “The
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20. Appendix: The NCAA Cartel 21. S
Page 12 and 13: Introduction: A Brief History of U.
Page 14 and 15: In the twentieth century, per capit
Page 16 and 17: Appendix: The 35 Largest National E
Page 18 and 19: Multiple Choice: ___ 1. The Jamesto
Page 20 and 21: 2. Describe the economic cost of th
Page 22 and 23: Chapter 1 Scarcity and Choices The
Page 24 and 25: Example 5B: At the end of 1982, the
Page 26 and 27: Example 11: When Cindy quits her jo
Page 28 and 29: consequences may result in failure
Page 30 and 31: An upward sloping curve (as in Exam
Page 32 and 33: In making decisions, humans tend to
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Page 36 and 37: ___ 13. If the value of one variabl
Page 38 and 39: Y Point X Y A 0 1 B 3 3 C 6 5 D 9 7
Page 40 and 41: Chapter 2 Trade and Economic System
Page 42 and 43: Example 4B: The following quantitie
Page 44 and 45: 1. An increase in the quantity of r
Page 46 and 47: 3. For whom to produce? This is det
Page 48 and 49: The graph below illustrates the shi
Page 50 and 51: The two primary economic systems ar
Page 52 and 53: ___ 12. The capitalist vision sees
Page 54 and 55: ___ 25. According to the book “Ca
Page 56 and 57: Chapter 3 Demand, Supply, and Equil
Page 58 and 59: . For inferior goods, income and de
Page 60 and 61: The same information can be placed
Page 64 and 65: $7 - 6 - 5 - S 3 S1 S 2 Price 4 - 3
Page 66 and 67: Example 17: The graph below illustr
Page 68 and 69: Questions for Chapter 3 Fill-in-the
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Page 72 and 73: $8 - 7 - 6 - 5 - Price 4 - 3 - 2 -
Page 74 and 75: Chapter 4 Inflation and Unemploymen
Page 76 and 77: Computing the Rate of Inflation The
Page 78 and 79: Full Employment Though unemployment
Page 80 and 81: 3. Cyclical unemployment - due to d
Page 82 and 83: During the Great Depression, the ec
Page 84 and 85: Appendix: Think Like an Economist -
Page 86 and 87: Answer questions 8. and 9. based on
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Page 90 and 91: Chapter 5 Measuring Total Output: G
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Page 94 and 95: The U.S. is a high per capita GDP c
Page 96 and 97: Example 17: In “An International
Page 98 and 99: The simple circular flow diagram be
Page 100 and 101: ___ 3. Which of the following would
Page 102 and 103: 2. Explain what nonproduction trans
Page 104 and 105: Chapter 6 The Aggregate Market The
Page 106 and 107: Example 2C: Assume the same facts a
Page 108 and 109: Example 5B: The price of crude oil
Page 110 and 111: Price Level Real GDP SRAS AD 2 AD 1
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Appendix: Why the Aggregate Demand
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___ 3. DEF Company can invest in ne
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2. List and explain the two factors
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Chapter 7 Classical Economic Theory
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Notice that the investment demand c
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Long-Run Equilibrium If Real GDP is
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Example 6B: When the economy is in
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Laissez-faire If the economy is sel
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___ 5. According to Say’s Law: a.
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3. On the graph below, draw an aggr
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Chapter 8 Keynesian Economic Theory
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Example 2B: The graph below illustr
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Example 5: Assume that the table be
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Notice on the graph on the previous
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According to Keynesian theory, a ch
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“The General Theory” also inclu
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___ 8. If the consumption function
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3. If the MPC is .667, and investme
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Chapter 9 Fiscal Policy The basic e
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Keynesian Fiscal Policy Theory and
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Example 5A: The federal government
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The Laffer Curve What will happen t
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Appendix: The Importance of Incenti
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___ 4. A decrease in government exp
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2. Explain what automatic stabilize
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Chapter 10 Money, Money Creation, a
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Example 4B: The castaways on Gillig
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Looking at the balance sheet below,
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Demand-side One-shot Inflation Exam
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4. Inflation increases uncertainty
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life; it came into existence not by
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calculated by using the potential d
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___ 12. If the required-reserve rat
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4. Referring to the balance sheet f
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Chapter 11 The Federal Reserve Syst
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5. After Bank X sells the $300,000
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Low Mortgage Interest Rates Mortgag
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Relaxed Standards for Mortgage Loan
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The Bursting of the Housing Bubble
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On February 17, 2009, the federal g
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Fed policies caused short-term inte
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___ 10. The Fed’s most important
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___ 25. In response to the recessio
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Chapter 12 Monetary Policy The basi
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2. A change in aggregate demand (AD
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Monetarist Transmission Mechanism C
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3. Borrowers do not have to seek ou
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Appendix: Book Review - “The Age
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Questions for Chapter 12 Fill-in-th
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___ 16. The primary source of incom
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7. According to Alan Greenspan, wha
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Chapter 13 Taxes, Deficits, and the
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Example 5: In 2015, Taxpayer A had
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of $5 and a quantity of 10 units. T
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The complexity of the tax law also
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the current government spending and
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cut of 1964. The top rate was lower
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___ 6. Federal excise taxes: a. are
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3. How would eliminating the loopho
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Chapter 14 Economic Growth The basi
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2. Labor. Labor can contribute to e
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estricting international trade (e.g
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An improvement in technology (e.g.
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The table below shows the economic
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will increase both Real GDP and per
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___ 8. Which of the following is co
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___ 26. The opinion that economic g
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Chapter 15 Less Developed Countries
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Example 8: Countries A, B, C, and D
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Obstacles to Economic Development f
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c. Restrictions on international tr
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Appendix: Book Review - “The Powe
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Example 25: In Brazil, about half t
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Study Guide for Chapter 15 Chapter
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___ 13. Among the counterproductive
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4. List four ways that governments
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Chapter 16 International Trade The
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Other Benefits of Free Internationa
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Example 6: The graph below illustra
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competitive disadvantage. But dumpi
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is only 25% as productive as before
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Smith was skeptical of government a
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___ 4. For Country X, what is the o
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___ 18. Frédéric Bastiat’s “P
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4. On the graph below: (1) What is
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Chapter 17 Elasticity We are often
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Example 4A: What is price elasticit
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Example 5A: Gertie’s Gas and Go i
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Example 10A: When the price of Good
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Example 13B: On the graph below, su
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$7 - 6 - 5 - Price 4 - 3 - 2 - 1 -
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In the long run, would the deadweig
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___ 7. The factors that determine w
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3. a. Which price (or prices) from
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Chapter 18 Utility The basic econom
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Nonetheless, society generally assu
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Example 9: Capital City operates a
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Marginal rate of substitution - the
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The diamond-water paradox is the ob
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Complete the table below to answer
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4. The graph below shows indifferen
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Chapter 19 The Firm The basic econo
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than contributing to team productio
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1. Difficulty in raising large amou
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Corporations also use self-financin
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Example 24: A blacksmith who produc
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For financing needs, proprietorship
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___ 13. Corporations: a. are comple
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5. List two things that the absence
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Chapter 20 Production and Costs The
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In Example 5B, Birdwell finds that
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variable cost initially decreases,
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Quantity TC MC AFC AVC ATC 0 240 X
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If the scale of operation is increa
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average total cost. Average fixed c
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___ 11. Concerning the cost curves:
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5. Complete the following cost tabl
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Chapter 21 Perfect Competition The
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Even though a perfect competitor ca
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Example 6C: This example builds on
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At what price will there be neither
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Appendix: Perfect Competition in th
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Multiple Choice: ___ 1. A perfect c
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___ 17. Perfect competition: a. req
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Answers for Chapter 21 Fill-in-the-
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Chapter 22 Monopoly Of the four mar
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3. Exclusive ownership of an essent
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maximizing quantity (4 units) creat
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$22 - 20 - 18 - 16 - 14 - Deadweigh
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2. Negotiating, beginning at a high
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Legal barriers are created by gover
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___ 8. The slope of the demand curv
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Price Quantity 3. List some of the
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Chapter 23 Monopolistic Competition
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For Percomp (the perfect competitor
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Example 7A: The graph below represe
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Example 9: The Organization of the
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Example 12 illustrates the dilemma
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its current price and quantity. The
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___ 14. Game theory: a. is a method
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Answers for Chapter 23 Fill-in-the-
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Chapter 24 Factor Markets The basic
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$ $240 - 200 - 160 - 120 - 80 - 40
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Since producers will attempt to equ
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2. Differences in nonmoney aspects
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were his strikeouts, walks, and hom
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___ 3. To maximize profits, a produ
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___ 19. According to the book, “M
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Multiple Choice: 1. a. 8. c. 15. d.
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Chapter 25 Labor Unions The primary
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The elasticity of demand for union
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Example 4A: Assume that the graph b
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Notice from the graph in Example 6
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Wage Factory A Quantity of Labor S
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As a cartel, a labor union faces a
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___ 10. For a monopsony: a. there i
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3. The graph below represents a lab
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Chapter 26 Interest, Present Value,
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An increase in expected rates of re
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An asset is valuable because we exp
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Example 13B: General Ordnance prove
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Appendix: Present Value Table One f
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___ 4. An increase in expected rate
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Problems: 1. List and explain the t
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Chapter 27 Market Failure The basic
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External Benefit If a market genera
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Example 2: To encourage the consump
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$100 - 90 - 80 - MSC 70 - $ 60 - 50
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A common good is nonexcludable. Non
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___ 5. What government policy would
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4. Based on the information on the
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Chapter 28 Public Choice and Govern
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Candidates and the Median Voter Mod
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Example 8: According to State and F
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Example 10: When Elvis Presley was
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4. Pessimistic bias. This is the te
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___ 5. An elected official will: a.
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2. If a certain policy will yield s
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Chapter 29 Government Regulation of
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underproduction is the amount that
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micromanagement results in business
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market. They may agree with their c
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Questions for Chapter 29 Fill-in-th
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___ 10. The public interest theory
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4. List the four types of costs imp
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Chapter 30 Agriculture and Health C
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weather may cause bumper crops. Bad
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Security and Rural Investment Act o
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Example 12: From 1960 to 2013, the
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1. NHI would provide universal heal
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d. Insurance providers are not allo
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Answer questions 7. through 10. by
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___ 21. If there were no individual
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Chapter 31 Income Distribution and
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Income is more equally distributed
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over a typical career is the accumu
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Ideal Income Redistribution The ide
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Poverty - a family whose income fal
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Appendix: Income Inequality around
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How is this story an analogy for th
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___ 2. In 2013, the Lowest Income 6
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Problems: 1. Explain the two primar
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Absolute advantage - when one natio
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Fiat money - money by government de
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Nonrivalrous good - a good for whic
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Absolute advantage, 16-9 Absolute e
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“Company town”, 25-6 Comparativ
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Eli Lilly and Company, 22-1 Emergen
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Houston, Texas, 15-10 Human capital
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Market, 3-1, 3-8-9 Market basket, 4
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Political bias, 9-4, 12-7 Political
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Short run production, 20-2-3 Short-
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Upturns, 9-4 USDA, 27-9, 30-1-2, 30
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