Elasticity
Elastic
If the quantity demanded is very responsive to changes in price, the % change in quantity demanded will be greater than the % change in price, and the price elasticity of demand will be greater than 1 in absolute value
o E>1
Inelastic
when the quantity demanded is not very responsive to price; however, the % change in price, and the price elasticity of demand will be less than 1 in absolute value
o 0<E<1
Unit Elastic
where the % change in quantity demanded is equal to the % change in price, the price elasticity of demand equals -1 (or 1 in absolute value)
o E=1
Price Elasticity of Demand
% change in quantity / % change in price
Midpoint Formula
Determinants of Price Elasticity of Demand
· Availability of close substitutes
o How consumers react to a change in the price of a product depends on whether there are alternative products
o The most important determinant of the price elasticity of demand
o If a product has more substitutes available, it will have a more elastic demand
o If a product has fewer substitutes available, it will have a less elastic demand
· Passage of time
o The more time that passes, the more elastic the demand for a product becomes
· Necessities v luxuries
o Goods that are luxuries usually have more elastic demand curves than goods that are necessities
· Definition of the market
o The more narrowly we define a market, the more elastic the demand will be
· Share of a good in a consumer’s budget
o The demand for a good will be more elastic the larger the share of the good in the average consumer’s budget
Total Revenue
the total amount of funds it receives from selling a good or service
TR=PxQ
Inelastic Demand
Price increase -- TR increase
Price decrease -- TR decrease
Prince increase -- TR decrease
Price decrease -- TR increase
Cross-Price Elasticity of Demand
% change Q of good X / % change P of good Y
· An increase in the price of a substitute will lead to an increase in the quantity demanded, so the cross-price elasticity of demand will be positive
· An increase in the price of a complement will lead to a decrease in the quantity demanded, so the cross-price elasticity of demand will be negative
Income Elasticity of Demand
A measure of the responsiveness of quantity demanded to changes in income
% change in Q / % change in income
Price Elasticity of Supply
the effect of a price change on the quantity demanded
Technology
Technological Change
Positive Technological Change
Negative Technological Change
Short Run
the period of time during which at least one of a firm’s inputs is fixed
o Can respond somewhat but limited
Long Run
the period of time in which a firm can vary all its inputs, adopt new technology, and increase or decrease the size of its physical plant
o Can change anything
o Everything is variable in the long run
Total Cost
The cost of all the inputs a firm uses in production
TC = FC + VC
Variable Cost
Costs that change as output changes
VC = Wage rate x Q of workers used
VC = TC - FC
Fixed Cost
Costs that remain constant as output change
FC = TC - VC
Explicit Costs
Implicit Costs
a nonmonetary opportunity cost
o Not actually paying them but want to consider them
Accounting Costs
explicit costs
Economic Costs
explicit and implicit costs
Accounting Profit
A firm’s net income, measured as revenue – operating expenses and taxes paid
Economic Profit
a firm’s revenue – all of its implicit and explicit costs
Production Function
Law of Diminishing Marginal Returns
MPL < APL
APL is decreasing
MPL = APL
APL is at a maximum
As output increase
AFC gets smaller
the difference between ATC and AVC decreases
Long-run ATC Curve
Economies of Scale
the situation in which a firm’s long run average cost falls as it increases the quantity of output it produces
o Per unit costs are falling as things get bigger
Diseconomies of Scale
the situation in which a firm's long-run average cost rises as the firm increases output
Constant Returns to Scale
the situation in which a firm's long-run average costs remain unchanged as it increases output
Minimum Efficient Scale
the level of output at which all economies of scale are exhausted
o Per unit costs are increasing
o Minimizing per unit costs
The marginal product of labor initially increases due to specialization and then decreases due to diminishing returns
Whenever the marginal product of labor is greater than the average product of labor, it pulls the average product of labor
up
A.
the MC curve is passing through the minimum point of the ATC curve.
B.
as the ATC curve falls, the MC curve lies below it and when the ATC curve rises, the MC curve lies above it.
C.
the ATC curve is U shaped.
a firm’s marginal costs will eventually increase as the firm expands output in the short run.
The firm’s average total costs will be at a minimum at the output level where the
marginal cost curve crosses the firm’s average total cost curve
Relationship Between MPL and Total Cost
When MPL is positive and increasing, total product increases at an increasing rate
When MPL is positive and decreasing, total product increases at a decreasing rate. When MPL is negative, total product decreases
Relationship Between MPL and MC Curve
When MPL increases, MC decreases
When MPL decreases, MC increases
When MPL is at its maximum, MC is at its minimum.
Relationship Between MC and ATC Curves
When MC is less than ATC, ATC decreases.
When MC is greater than ATC, ATC increases.
MC intersects ATC at the minimum point of ATC.
3 conditions for a perfectly competitive market
o Many buyers and sellers
Not one will be able to influence the market
o All firms selling identical products
Homogenous product
o No barriers to new firms entering the market
Price Taker
A buyer or seller that is unable to affect the market price
Average Revenue
AR = TR/Q
Marginal Revenue
MR>MC
MR<MC
P>ATC
earning a profit
P<ATC
Suffering a loss
P=ATC
Breaking even
Shutdown point
Productive Efficiency
Allocative Efficiency
Which portion of the marginal cost curve is used to create a firm’s short-run supply curve?
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