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Elasticity
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A measure of how much one economic variable responds to changes in another economic variable.
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price elasticity of demand
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The responsiveness of the quantity demanded to a change in price
Ed = -(% change in Qd/% change in price)
Ed = 1 unit elastic
Ed < 1 inelastic
Ed > 1 elastic
Ed = -(% change in Qd/% change in price)
Ed = 1 unit elastic
Ed < 1 inelastic
Ed > 1 elastic
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Determinants of Price Elasticity of Demand
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availability of substitutes, necessity vs luxury, passage of time, definition in market, share of a good in consumer's budget
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Arc Formula
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(Q2-Q1/Q1+Q2)/(P2-P1/P1+P2)
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income elasticity of demand
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measures how a change in income affects spending
Ei = % change in Qd/% change in income
Ei > 0 normal good
Ei < 0 inferior good
Ei = % change in Qd/% change in income
Ei > 0 normal good
Ei < 0 inferior good
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cross-price elasticity of demand
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measures the responsiveness of the quantity demanded of one good to a change in the price of a related good
Ec = % change in Qd good x/% change in price good y
Ec > 0 substitute goods
Ec < 0 complement goods
Ec = 0 non-related goods
Ec = % change in Qd good x/% change in price good y
Ec > 0 substitute goods
Ec < 0 complement goods
Ec = 0 non-related goods
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price elasticity of supply
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the responsiveness of the quantity supplied to a change in price
Es = % change in Qs/% change in price
Es > 1 elastic
Es = 1 unit
Es < 1 inelastic
Es = % change in Qs/% change in price
Es > 1 elastic
Es = 1 unit
Es < 1 inelastic
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consumer surplus
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the difference between WTP and market price
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Total Cost (TC)
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TC = FC + VC
TC = Q x ATC
TC = Q x ATC
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Total Revenue (TR)
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TR = P x Q
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Profit
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Profit = TR - TC
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Average Total Cost (ATC)
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ATC = TC/Q
ATC = AFC + AVC
ATC = AFC + AVC
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Average Fixed Cost (AFC)
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AFC = FC/Q
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Average Variable Cost (AVC)
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AVC=VC/Q
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Marginal Cost (MC)
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MC = change in TC / change in Q
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Marginal product of labor (MPL)
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additional output a firm produces as a result of hiring one more worker
MPL = Change in Q / Change in Labor
MPL = Change in Q / Change in Labor
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Average Revenue (AR)
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AR = TR/Q
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Marginal Revenue (MR)
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MR = change in TR/ change in Q
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Accounting profit
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Accounting Profit = Total revenue − Explicit Costs.
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Economic profit
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economic profit = total revenue - explicit costs - implicit costs
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variable cost
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costs that vary with the quantity of output produced
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fixed cost
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a cost that does not change, no matter how much of a good is produced
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explicit costs
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input costs that require an outlay of money by the firm - tied directly to the production of goods
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implicit costs
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opportunity costs of production
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Law of diminishing marginal product
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At some point adding more of a variable input, such as labor, to the same amount of fixed inputs, will cause the marginal product of the variable input to decline
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best output to maximize profit
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MR = MC
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shutdown
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stop producing, but stay in business. Have fixed costs - short run. Ex. seasonal shops
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Exit
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close the business. No fixed costs. takes time
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How much to produce?
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MC=P produce at this level
MC<P increase output
MC>P decrease output
MC<P increase output
MC>P decrease output
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Shutdown decision
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Revenue>VC = produce
Revenue<VC = shut down
Revenue<VC = shut down
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Long Run Perfect Competiton
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In the long run in a perfectly competitive market, economic profit = 0
Long run equilibrium: P=ATC and Profit=0 as long as production costs are identical
Long run equilibrium: P=ATC and Profit=0 as long as production costs are identical
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