What will happen to the equilibrium price of new cars if the price of gasoline rises and auto

Here is the second part of the study guide.

Graphs are a difficult to do quickly, so the answers to the suggested questions have just words.  You should, however, be able to go beyond and include graphs as well as provide information about what will happen to the price and the quantity in the new equilibrium.

3-3       What effect will each of the following have on the demand for small automobiles such as the Mini Cooper or Smart car?

a.   Small automobiles become more fashionable.

b.   The price of large automobiles rises.

c.   Income declines and small autos are an inferior good.

d.   Consumers anticipate that the price of small autos will greatly come down in the near future.

e.   The price of gasoline substantially drops.

Demand increases in (a), (b), and (c); decreases in (d).  The last one (e) is ambiguous.  As autos and gas are complements, one could argue that the decrease in gas prices would stimulate demand for all cars, including small ones.  However, one could also argue that small cars are attractive to consumers because of fuel efficiency, and that a decrease in gas prices effectively reduces the price of the �gas guzzling� substitutes.  That would encourage consumers to switch from smaller to larger cars (SUVs), and demand for small automobiles would fall.  [The latter argument is the stronger of the two, but it presents a good illustration of the complexity of many of these changes.]

3-6       What effect will each of the following have on the supply of automobile tires?

a.   A technological advance in the methods of producing tires.

b.   A decline in the number of firms in the tire industry.

c.   An increase in the price of rubber used in the production of tires.

d.   The expectation that the equilibrium price of auto tires will be lower in the future than it is currently.

e.   A decline in the price of large tires used for semi-trucks and earth hauling rigs (with no change in the price of auto tires). 

f.    The levying of a per-unit tax in each auto tire sold.

g.   The granting of a 50-cent-per-unit subsidy for each auto tire produced.

Supply increases in (a), (d), (e), and (g); decreases in (b), (c), and (f).

10-5      How will each of the following affect the demand for resource A, which is being used to produce commodity Z?

            a.   An increase in the demand for product Z.

            b.   An increase in the price of substitute resource B.

            c.   A technological improvement in the capital equipment with which resource A is combined.

            d.   A fall in the price of complementary resource C.

            e.   A decline in the elasticity of demand for product Z due to a decline in the competitiveness of   the product market.

            Increase in the demand for resource A: (a), (c), (d).  We have not covered elasticity so (e) is not possible, but is is a decrease in the demand for A: (e) � lower output with imperfect competition implies less resource demand.  Technically this is uncertain: (b) � depends on whether the output or substitution effect is larger, but we did not cover that.  I could, however, ask what would happen if there was an increase in capital.  Your answer would be and increase in demand.

THE COSTS OF PRODUCTION

KEY POINTS: 

1.       The goal of firms is to maximize profit, which equals total revenue minus total cost.

2.       When analyzing a firm�s behavior, it is important to include all the opportunity costs of production.  Some of the opportunity costs, such as the wages a firm pays its workers, are explicit.  Other opportunity costs, such as the wages the firm owner gives up by working in the firm rather than taking another job, are implicit.

3.       A firm�s costs reflect its production process.  A typical firm�s production function gets flatter as the quantity of an input increases, displaying the property of diminishing marginal product, crowding.  As a result, a firm�s total-cost curve gets steeper as the quantity produced rises.

 4.       A firm�s total costs can be divided between fixed costs and variable costs.  Fixed costs are costs that do not change when the firm alters the quantity of output produced.  Variable costs are costs that do change when the firm alters the quantity of output produced.

5.       From a firm�s total cost, an important related measure of cost is derived.  Marginal cost is the amount by which total cost would rise if output were increased by one unit.

6.       A firm maximizes profit when MR = MC

I.          What Are Costs?

 A.         Total Revenue, Total Cost, and Profit

     1.         Goal of a firm: to maximize profit.

     2.         Definition of Total Revenue: the amount a firm receives for the sale of its output.

     3.         Definition of Total Cost: the market value of the inputs a firm uses in production.

     4.         Definition of Profit: total revenue minus total cost.

  B.         Costs as Opportunity Costs

     1.         The cost of something is what you give up to get it.

     2.         The costs of producing an item must include all of the opportunity costs of inputs used in production.

     3.         Total opportunity costs include both implicit and explicit costs.

         a.         Definition of Explicit Costs:  input costs that require an outlay of money by the firm.

          b.         Definition of Implicit Costs:  input costs that do not require an outlay of money by the firm.

          c.          This is the major way in which accountants and economists differ in analyzing the performance of a company.

         d.         Accountants focus on only explicit costs, while economists examine both explicit and implicit costs.

  C.         The Cost of Capital as an Opportunity Cost

         1.         The opportunity cost of financial capital is an important cost to include in any analysis of firm performance.

     A.         The Production Function

         1.         Definition of Production Function: the relationship between quantity of inputs used to make a good and the quantity of output of that good.

3.         Definition of Marginal Product: the increase in output that arises from an additional unit of input.

1.         Definition of Fixed Costs: costs that do not vary with the quantity of output produced.

2.         Definition of Variable Costs: costs that do vary with the quantity of output produced.

4.         Definition of Marginal Cost: the increase in total cost that arises from an extra unit of production.

1.         Total revenue from the sale of output is equal to price times quantity.

3.         Definition of Marginal Revenue: the change in total revenue from an additional unit sold.

2.         The profit-maximizing quantity can also be found by comparing marginal revenue and marginal cost.

a.         As long as marginal revenue exceeds marginal cost, increasing output will raise profit.

b.         If marginal revenue is less than marginal cost, the firm can increase profit by decreasing output.

THE MARKETS FOR THE FACTORS OF PRODUCTION

KEY POINTS:

1.       The economy�s income is distributed in the markets for the factors of production.  The three most important factors of production are labor, land, and capital.

2.       The demand for factors, such as labor, is a derived demand that comes from firms that use the factors to produce goods and services.  Competitive, profit-maximizing firms hire each factor up to the point at where the marginal revenue product of the factor equals its price.

3.       The supply of labor arises from individuals� tradeoffs between work and leisure.  An upward-sloping labor supply curve means that people respond to an increase in the wage by enjoying less leisure and working more hours.

 4.       The price paid to each factor adjusts to balance the supply and demand for that factor.  Because factor demand reflects the marginal revenue product of that factor, in equilibrium each factor is compensated according to its marginal contribution to the production of goods and services.

The Marginal Revenue Product and the Demand for Labor

         1.         When deciding how many workers to hire, the firm considers how much profit each worker would bring in.

         2.         Because Profit = Total Revenue � Total Cost, the profit from an additional worker is the worker�s contribution to revenue minus the worker�s wage.

         3.         Definition of Marginal Revenue Product: the marginal product of labor times the price of the output.

What Causes the Labor Demand Curve to Shift?

                        1.         The Output Price

                                   a.          An increase in the price of the product raises the marginal revenue product of labor and therefore increases the demand for labor.

                                   b.          An decrease in the price of the product lowers the marginal revenue product of labor and therefore decreases the demand for labor.

                         2.         Productivity

                                    a.          Technological advance raises the marginal product of labor, which in turn raises the value of the marginal product of labor.

                                     b.         Thus, any new technology will lead to an increase in the demand for labor.

                                     c.          Increases in the level of education be workers will increase the demand for labor.

                        3.         The Supply of Other Factors

                                 a.         The quantity available of one factor can affect the marginal product of another.

b.         Therefore, any change in the availability of another factor will likely affect the demand for labor.

                                     c.     An increase in capital will increase the demand for labor.

III.        The Supply of Labor

             A.         The Tradeoff between Work and Leisure

                 1.         Any hours spent working are hours that could be devoted to something else like studying, or watching television.  Economists refer to all time not spent working for pay as �leisure.�

                2.         The opportunity cost of an hour of leisure is the amount of money that would have been earned if that hour was spent at work.

                3.         Therefore, as the wage increases, so does the opportunity cost of leisure.

                4.         The labor supply curve shows how individuals respond to changes in the wage in terms of the labor-leisure tradeoff.

a.         An upward-sloping labor supply curve means that an increase in the wage induces workers to increase the quantity of labor they supply.

            B.         What Causes the Labor Supply Curve to Shift?

                        1.         Changes in Tastes (for leisure vs. working)

                        2.         Changes in Alternative Opportunities (other occupations)

                        3.         Immigration

1.       A price ceiling is a legal maximum on the price of a good or service.  An example is rent control.  If the price ceiling is below the equilibrium price, the quantity demanded exceeds the quantity supplied.  Because of the resulting shortage, sellers must in some way ration the good or service among buyers.

2.       A price floor is a legal minimum on the price of a good or service.  An example is the minimum wage.  If the price floor is above the equilibrium price, the quantity supplied exceeds the quantity demanded.  Because of the resulting surplus, buyers� demands for the good or service must in some way be rationed among sellers.

I.          Controls on Prices

A.         Definition of Price Ceiling: a legal maximum on the price at which a good can be sold.

B.         Definition of Price Floor: a legal minimum on the price at which a good can be sold.

C.         How Price Ceilings Affect Market Outcomes

If the price ceiling is lower than the equilibrium price, the ceiling is a binding constraint and a shortage is created.

a.         In 1973, OPEC raised the price of crude oil which led to a reduction in the supply of gasoline.

                                     b.         The federal government put price ceilings into place and this created large shortages.

                                     c.          Motorists were forced to spend large amounts of time in line at the gas pump (which is how the gas was rationed).

                                     d.         Eventually, the government realized its mistake and repealed the price ceiling.

        D.           How Price Floors Affect Market Outcomes

If the price floor is higher than the equilibrium price, the floor is a binding constraint and a surplus is created.

a.         The market for labor looks like any other market: downward-sloping demand, upward-sloping supply, equilibrium price (called a wage), and equilibrium quantity of labor hired.

b.         If the minimum wage is above the equilibrium wage in the labor market, a surplus of labor will develop (unemployment).

c.          The minimum wage will be a binding constraint only in markets where equilibrium wages are low.

d.         Thus, the minimum wage will have its greatest impact on the market for teenagers and other unskilled workers.

What will happen to the equilibrium price of new cars if the price of gasoline rises and auto

What will happen to the equilibrium price and quantity of gasoline?

What happens to equilibrium price when price increases?

What will happen to the equilibrium price and quantity of new cars if the price of gasoline rises the price of steel rises public transportation becomes cheaper?