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elastic
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a demand curve is elastic when an increase in price reduces the quantity demanded A LOT
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inelastic
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when the same price increase reduces the quantity demanded JUST A LITTLE, then the demand is inelastic
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price elasticity of demand
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the more responsive quantity demanded is to a change in price, the more elastic the demand curve is
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elasticity rule
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elasticity DOES NOT equal slope, but if 2 linear demand (or supply curves run through a common point, then at any given quantity, the curve that is FLATTER is more elastic
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price elasticity of demand formula
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the percentage change in quantity demanded divided by the percentage change in price
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If the price of oil increases by 10% and the quantity demanded falls by 5%, then the price elasticity of demand for oil is:
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5%/10%= 0.5
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price elasticity of demand using the midpoint formula
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instead of dividing the initial quantity or price, we'll use the average quantity or price
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Classifications of Price Elasticity of Demand
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- A good can have a price elasticity as low as zero or as high as infinity
- If |Ed|<1, the demand curve is INELASTIC
- If |Ed|>1, the demand curve is ELASTIC
-If |Ed|=1, the demand curve is UNIT ELASTIC
- If |Ed|<1, the demand curve is INELASTIC
- If |Ed|>1, the demand curve is ELASTIC
-If |Ed|=1, the demand curve is UNIT ELASTIC
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perfectly inelastic demand
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-an increase in price leaves the quantity demanded UNCHANGED
-Price Elasticity of Demand= 0
-Price Elasticity of Demand= 0
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perfectly elastic demand
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-price elasticity of demand= infinity
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unit elasticity of demand
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-price elasticity of demand= 1
-a 20% increase in the price generates a 20% decrease in quantity demanded
-a 20% increase in the price generates a 20% decrease in quantity demanded
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total revenue
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-TR= P*Q
-sellers need to know how elastic their good is so they can plan
-sellers need to know how elastic their good is so they can plan
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effect of a price increase to Total Revenue
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-Price effect of price increase: higher prices for each unit sold
-quantity effect on price increase: fewer units sold
-quantity effect on price increase: fewer units sold
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inelasticity and total revenue
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-when demand is inelastic, the price effects DOMINATE the quantity effect
-so an increase in price will cause only a slight reduction in the quantity demanded
-so an increase in price will cause only a slight reduction in the quantity demanded
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elasticity and total revenue
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-when demand is elastic, the quantity effect DOMINATES the price effect
-so an increase in price will cause a significant reduction in the quantity demanded
-so an increase in price will cause a significant reduction in the quantity demanded
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unit elasticity and total revenue
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-when demand is unit-elastic, the quantity effect EQUALS the price effect
-so an increase in price exactly balances the reduction in quantity demanded
-so an increase in price exactly balances the reduction in quantity demanded
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Factors that Determine Price Elasticity of Demand
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1. Availability of close substitutes is very important
2. Whether the good is a necessity or a luxury also affects the elasticity of demand
3. The share of income spent on the good matters
4. The length of time elapsed since the price changed matters
2. Whether the good is a necessity or a luxury also affects the elasticity of demand
3. The share of income spent on the good matters
4. The length of time elapsed since the price changed matters
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Cross-Price Elasticity of Demand
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measures how sensitive the quantity demanded of Good A is to the price of Good B
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Substitutes and cross-price elasticity of demand
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- for substitutes, cross-price elasticity of demand is POSITIVE
- an increase in the price of one brand of cookies will increase the demand for other brands
- an increase in the price of one brand of cookies will increase the demand for other brands
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Complements and cross-price elasticity of demand
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- for complements, cross-price elasticity of demand is NEGATIVE
- an increase in the price of milk causes a decrease in the demand for oreos
- an increase in the price of milk causes a decrease in the demand for oreos
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Income Elasticity of Demand
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measures how sensitive the quantity demanded of a good is to changes in income
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Income Elasticity of Demand and Normal Goods
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income elasticity is POSITIVE
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Income Elasticity of Demand and Inferior Goods
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income elasticity is NEGATIVE
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Price Elasticity of Supply
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percent change in quantity supplied divided by percent change in price
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perfectly inelastic supply
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-an increase in price leaves the quantity unchanged
-price elasticity of supply=0
-price elasticity of supply=0
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perfectly elastic supply
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price elasticity of supply= infinity
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price elasticity of supply curve
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-compares sensitivity of quantity supplied to changes in price
-the same price increase causes a SMALL increase in Qs if supply is INELASTIC
-the same price increase causes a BIG increase in Qs if supply is ELASTIC
-the same price increase causes a SMALL increase in Qs if supply is INELASTIC
-the same price increase causes a BIG increase in Qs if supply is ELASTIC
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Elasticity of Supply definition
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-a supply curve is ELASTIC if a rise in price increases the quantity supplied A LOT
-a supply curve is INELASTIC if sellers change quantity supplied JUST A LITTLE
-a supply curve is INELASTIC if sellers change quantity supplied JUST A LITTLE
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Factors that Determine Price Elasticity of Supply
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1. Availability of Inputs
2. Time
2. Time
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Effects of Taxes
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-taxes are necessary... but have costs and create distortions
-every tax has efficiency and equity effects
-every tax has efficiency and equity effects
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excise tax
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a tax on a sale of a good or service
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tax rate
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amount of tax people are required to pay per unit of whatever is being taxed
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tax revenue
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amount of tax income collected by the government, equal to the tax rate multiplied by the Quantity Sold
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effects of a tax
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a tax generates revenue and creates a deadweight loss
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Deadweight Losses from Taxes and Elasticity of Demand
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deadweight loss is LARGER when DEMAND is ELASTIC
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Deadweight Losses from Taxes and Elasticity of Supply
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deadweight loss is LARGER when SUPPLY is ELASTIC
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Deadweight Losses from Taxes and Inelasticity of Demand
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deadweight loss is SMALLER when DEMAND is INELASTIC
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Deadweight Losses from Taxes and Inelasticity of Supply
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deadweight loss is SMALLER when SUPPLY is INELASTIC
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production function
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relationship between the quantity of inputs a firm uses and the quantity of output it produces
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Fixed Inputs
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input whose quantity is fixed for a period and cannot be varied
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Variable Inputs
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input whose quantity the firm can vary at any time
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Long Run
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period in which all inputs can be varied
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Short Run
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period in which at least 1 input is fixed
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Marginal Product
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-change in output resulting from a one-unit increase in the amount of labor input
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Fixed Cost
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cost that does not depend on the quantity of output produced, it is the cost of the fixed input
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Variable Cost
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cost that depends on quantity of output produced, it is the cost of variable input
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Total Cost Curve
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-becomes steeper as more output is produced, a result of diminishing returns
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Marginal Cost
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change in total cost divided by change in quantity of output
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Spreading Effect
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the larger the output, the more output which fixed cost is spreading, leading to a lower Average Fixed Cost
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Diminishing Returns Effect
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the larger the output, the more variable input required to produce additional units, leading to a higher Average Variable Cost
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The price elasticity of demand measures the responsiveness of the change in the:
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quantity demanded to a change in price
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When demand is _________, a rise in price leads to a ________ in total revenue.
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inelastic; increase
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Since the price of walnuts increases as the demand for cashews increase, we can assume that these 2 goods are:
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substitutes
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There are several close substitutes for aspirin but fewer substitutes for a complete medical exam. Therefore, all other things equal, you would expect the demand for:
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Bayer aspirin to be more price-elastic
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Goods are ______ when the cross-price elasticity of demand is positive and ______ when the cross-price elasticity of demand is negative.
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substitutes; complements
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For a normal demand curve, the price elasticity of demand will be:
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always negative
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A total product curve indicates the relationship between ____ when all other inputs are fixed.
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a variable input and output
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An assumption of perfect competition is:
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many buyers and sellers
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The term diminishing returns refers to:
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a decrease in the extra output due to the use of an additional unit of variable input when all other inputs are held constant.
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Diminishing marginal returns occurs when:
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each additional unit of a variable factor adds less to total output than the previous unit.
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Which of the following is NOT a characteristic of a perfectly competitive industry?
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products are differentiated
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market share
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the fraction of the total industry output accounted for by that producer's output
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price taker
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buyer and seller's actions have no effect on price
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perfectly competitive market
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a market in which all market participants are price takers
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perfectly competitive industry
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an industry in which producers are price takers
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standardized product (or commodity)
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consumers regard different seller's products as equivalent
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free entry and exit
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new producers can enter easily into an industry and exiting producers can easily leave an industry
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marginal benefit
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the additional benefit derived from producing one more unit of that good or service
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principle of marginal analysis
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says that the optimal amount of an activity is the quantity at which marginal benefits equals marginal costs
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optimal output rule
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profit is maximized by producing the quantity of output at which the marginal revenue at the last unit produced is equal to its marginal cost
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When is profit maximized?
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when MR=MC
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If TR>TC,
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the firm is profitable
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If TR=TC,
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the firm breaks even
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If TR<TC,
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the firm incurs a loss
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shut-down price
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minimum average variable cost
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short-run industry supply curve
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how the Q supplied by an industry depends on a market price (given a fixed # of producers)
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long-run equilibrium
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when the Q supplied equals the Q demanded
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