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Standard formula of computing percentage change:
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end value - start value / start value x 100%
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Midpoint method formula:
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end value - start value / end value + start value / 2 (midpoint) x 100%
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Price elasticity of demand
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a measure of the sensitivity of demand to changes in price
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Price elasticity of demand formula:
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% change in quantity demanded / % change in price
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Elasticity
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a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants
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Basic idea of elasticity
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how much one variable responds to changes in another variable
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Demand is elastic if...
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price elasticity of demand is greater than 1
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Demand is inelastic if...
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price elasticity of demand is less than 1
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Demand is unit elastic if...
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price elasticity of demand is equal to 1
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Price elasticity is higher when
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close substitutes are available, narrowly defined goods, luxuries, long run
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Price elasticity is lower when
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close substitutes not available, broadly defined goods, necessities, short run
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Elastic
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describes demand that is very sensitive to a change in price
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Inelastic
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describes demand that is not very sensitive to a change in price
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Unit elastic
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a given change in price causes a proportional change in quantity demanded
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Perfectly inelastic demand
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consumers have no price sensitivity, graph vertically
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Perfectly elastic demand
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consumers have extreme price sensitivity, graph horizontally
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Rule of thumb: the flatter the curve...
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the bigger the elasticity
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Rule of thumb: the steeper the curve...
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the smaller the elasticity
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Revenue
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price x quantity
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Price effects on revenue
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higher P means more revenue, but sell fewer units (lower Q) due to law of demand
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Price elasticity of supply
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a measure of how much the quantity supplied of a good responds to a change in the price of that good
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Price elasticity of supply formula:
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% change in quantity supplied / % change in price
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Why use midpoint method?
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you get the same answer either way, no matter which number you start and end with
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Examples of elastic goods
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soda, boats, beef, real estate, pizza, gold
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Examples of inelastic goods
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gasoline, diapers, chewing gum, medical care, toilet paper
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What happens to total revenue of an inelastic good if the price increases?
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Total revenue increases
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What happens to total revenue of an elastic good if the price increases?
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Total revenue decreases
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Profit formula:
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total revenue - total cost
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Explicit costs
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require an outlay of money (ex. paying wages to workers)
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Implicit costs
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do not require a cash outlay (ex. opportunity cost of giving up a job)
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Investments are not counted as...
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costs
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Accounting profit
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total revenue minus total explicit costs
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Economic profit
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total revenue minus total implicit and explicit costs
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Accounting profit ignores _______, so it is _______ than economic profit
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implicit costs, higher
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Production function
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shows the relationship between the quantity of inputs used to produce a good and the quantity of output of that good
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Production function can be represented by...
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a table, equation, or graph
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Production function shape:
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gets flatter as the amount of labor increases, resulting in a curved downwards shape
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Marginal product
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the increase in output that arises from an additional unit of input
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Marginal product of labor formula:
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change in quantity (output) / change in labor
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Why MPL is important:
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rational people think at the margin
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X-axis is the...
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quantity
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Y-axis is the...
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price
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Diminishing marginal product
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the marginal product of an input declines as the quantity of the input increases
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Total cost curve shape:
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U-shaped or upward-sloping
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Total cost (TC)
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fixed costs + variable costs
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Fixed costs (FC)
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do not vary with the quantity of output produced
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Variable costs (VC)
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vary with the quantity produced
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Average fixed cost (AFC) formula:
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fixed cost / quantity
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Average variable cost (AVC) formula:
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variable cost / quantity
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Average total cost (ATC) formula:
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AFC + AVC or total cost / quantity
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ATC is falling when...
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marginal cost is below it (ATC > MC)
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ATC is rising when...
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marginal cost is above it (ATC < MC)
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Costs in the short run
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some inputs are fixed (e.g., factories, land), the costs of these inputs are FC.
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Costs in the long run
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all inputs are variable
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SRATC curve
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each SRATC curve will have exactly one point that is tangent to the LRAC curve
this is the point that output in the short run reaches a minimum long run average cost for the amount of the input that is fixed in the short run
steeper than the LRAC curve because there are fixed costs in the short run
this is the point that output in the short run reaches a minimum long run average cost for the amount of the input that is fixed in the short run
steeper than the LRAC curve because there are fixed costs in the short run
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LRATC curve
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A curve that shows the lowest (unit) cost at which the firm can produce any given level of output.
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Economies of scale:
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ATC falls as Q increases
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Constant returns to scale:
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ATC stays the same as Q increases
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Diseconomies of scale:
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ATC rises as Q increases
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Economies of scale occur when
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increasing production allows greater specialization (more common when Q is low)
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Workers are more efficient when working on a
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narrow task
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Diseconomies of scale are due to
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coordination problems in large organizations (more common when Q is high)
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Marginal cost
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the increase in total cost that arises from an extra unit of production
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AFC always ____ as output rises
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decreases
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The ____ intersects the ____ at minimum average total cost
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MC curve, ATC curve
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Perfectly competitive market
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a market that meets the conditions of 1) many buyers and sellers, 2) all firms selling identical products, and 3) no barriers to new firms entering the market
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Total revenue (TR) formula:
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price x quantity
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Average revenue (AR) formula:
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total revenue / quantity
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Average revenue (AR) equals
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price
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Marginal revenue (MR)
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the change in total revenue from selling one more unit of a product
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Marginal revenue (MR) formula:
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change in total revenue / change in quantity
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For competitive firms,
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AR = P = MR
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If Q increases by one unit,
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revenue rises by MR, cost rises by MC
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If MR > MC,
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increase Q to raise profit
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If MR < MC,
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reduce Q to raise profit
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Shutdown
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a short-run decision not to produce anything because of market conditions
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Exit
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a long-run decision to leave the market
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If shut down in short run,
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must still pay fixed cost
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If exit in long run,
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there are zero costs
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Cost of shutting down:
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revenue loss = TR
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Benefit of shutting down:
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cost savings = VC (firm must still pay FC)
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Shut down if...
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P < AVC
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The marginal product of labor is equal to the
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increase in output obtained from a one unit increase in labor
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Andrea makes earrings. If she charges $20 for each earring, her total revenue will be
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$500 if she sells 25 earrings.
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Which of the following can be added to profit to obtain total revenue?
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total cost
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An example of an explicit cost of production would be the
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lease payments for the land on which a firm's factory stands.
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Marcus sells 300 candy bars at $0.50 each. His total costs are $125. His profits are
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$25.
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The difference between accounting profit and economic profit is
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implicit costs.
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An example of an opportunity cost that is also an implicit cost is
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the value of the business owner's time.
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When adding another unit of labor leads to an increase in output that is smaller than the increases in output that resulted from adding previous units of labor, the firm is experiencing
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diminishing marginal product.
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Profit is defined as
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total revenue minus total cost.
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Which of the following expressions is correct?
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accounting profit = economic profit + implicit costs
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Suppose that for a particular business there are no implicit costs. Then
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accounting profit will be the same as economic profit.
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A production function describes
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how a firm turns inputs into output.
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Total revenue equals
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price x quantity.
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Economists assume that the typical person who starts her own business does so with the intention of
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maximizing profits.
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Total profit formula:
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(P - ATC) x Q
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A firm's opportunity costs of production are equal to its
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explicit costs + implicit costs
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