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Elasticity
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measures the responsiveness of Qd or Qs to a change in one of its determinants
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Price Elasticity of Demand
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how much QD changes to a change in price of that good
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Price Elasticity of Demand Equation
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%change in Qd/% change in price
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Elastic
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huge change in Qd or Qs in repsonse to change in P
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Inelastic
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little change in Qd or Qs in response to the change in price
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Mid-Point Formula
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[(Q1-Q0)/average] / [(P1-P0)/average)] *use the absolute value
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Ed > 1
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elastic (non-steep negative slope)
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Ed < 1
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inelastic (steep negative slope)
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Ed = 0
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perfectly inelastic (vertical line)
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Ed= 1
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unit elastic (downward sloping curve)
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Ed = infinity
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perfectly elastic (horizontal line)
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An increase in price (elastic) causes...
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a decrease in total revenue
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Total Revenue =
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PQ
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A decrease in price (elastic) causes...
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an increase in total revenue
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An increase in price (inelastic) causes...
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an increase in total revenue
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A decrease in price (inelastic demand) causes...
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a decrease in total revenue
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Seller prefer...
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Inelastic markets
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Determinants of Elasticity
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1) # of substitutes
2) % of buyer's budget
3) necessity vs. luxury
4) time
2) % of buyer's budget
3) necessity vs. luxury
4) time
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Income Elasticity
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ratio of % in change in Qd to change in % income
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If income elasticity is > 0
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the good is normal
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If income elasticity is < 0
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the good is inferior
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Cross price elasticity of demand
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% change in Qd of good one / % change in price of another good
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Price Elasticity of Supply
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ratio of % change in Qs to % in change in price
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If cross price is positive...
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the goods are subsitutes
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If cross price is negative...
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the goods are complements
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There is a _____ price elasticity in the ____ run than the ____ run.
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higher, long, short
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Sellers receive ____ and buyers make _____.
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revenues, expenditures
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If there is a price change when demand is unit elastic...
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TR does not change
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Total revenue is maximized when...
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Ed=1
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Placement of a tax does not equal...
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payment of a tax
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If demand is perfectly inelastic...
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the buyer pays the full tax
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If demand is perfectly elastic...
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the seller pays the whole tax
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If supply is perfectly elastic...
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the buyer pays the full tax
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If supply is perfectly inelastic...
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the seller pays the full tax
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Lower price elasticity =
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more tax on the buyer
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Higher price elasticity =
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more tax on the seller
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What gives value? (In terms of the classicists)
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labor theory of value, diamond-water paradox
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What really determines value?
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marginal utility (Marginalist Revolution)
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Utility Function
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formula that assigns a level of utility to individual market baskets (more choices = better off)
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Total "monetary" Utility
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money = utility
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Law of diminishing Utility
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a law of economics stating that as a person increases consumption of a product while keeping consumption of other products constant, there is a decline in the marginal utility that person derives from consuming each additional unit of that product.
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Want to keep buying until...
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all MU/P are equal
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Arbitraged
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buy product, sell product, make profit
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Herbert Simon
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humans have limited rationality because they have limited information
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Heoristic
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make shortcuts to make decisions
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Prospect Theory
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investors frame choices of potential gains/losses relative to a specific reference point
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Loss Aversion
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take risks to avoid losses and do not take risks for gains
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Endowment Effect
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people place a higher value on goods that they already own
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Anchoring
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seller makes reference point for buyer
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Richard Thaler
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economists assume that people are rational, emotionless, and self-controlled, but they aren't
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John Maynard Keys
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many people just follow what other do, don't make rational decisions
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Behavioral Economists
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Adam Smith, Wilfredo Pareto, and John Maurice Clark
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Utils
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artificial construct to measure utility
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MU =
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changeTU/change Q
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Interpersonal Utility Comparison
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should not compare utilities between two people for a certain good
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Consumer's attempt to reach max utility shows...
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law of demand
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Compartmentalizing
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treating some dollars different than other
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Neuroeconomics
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the study of brain mechanisms at work during economic decision making
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People value ___ gains over ____ gains.
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current, future
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Indifference Curves
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shows two goods that yield the same utility
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People want the...
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highest indifference curve
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Marginal Rate of Substitution
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the rate at which a consumer/producer is willing to substitute goods and retain the same utility/output level (indifference curve)
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Budget/resource restraint
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limits utility
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What changes the budget line?
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1) changes in resources or income
2) changes in price
2) changes in price
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Consumer Equilibrium
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affordable good bundle that yeilds the highest utility
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You don't want to maximize ____. Instead maximize ____.
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constraint, utility (Economic illiteracy!)
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Firms exist because...
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sum of team production is > sum of individual production
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Shirking
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The behavior of a worker who is putting forth less than the agreed-to effort. Need a monitor.
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Incentive for monitor is...
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being a residual claimant
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Profit =
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total revenue - total cost
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Explicit costs
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input costs that require an outlay of money by the firm
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Implicit Costs
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input costs that do not require an outlay of money by the firm, opportunity costs
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Accounting Profit =
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total revenue - explicit costs
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Economic Profit =
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total revenue - explicit costs - implicit costs
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Normal Profit
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zero economic prodit
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Fixed Input
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an input whose quantity is fixed for a period of time and cannot be varied
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Variable Input
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an input whose quantity the firm can vary at any time due to production
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Short Run
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some inputs are fixed
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Long Run
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no inputs are fixed
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Marginal Physical Output (MPP)
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change in output from increasing one unit of input
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The Law of Diminishing Marginal Returns
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as you increase one factor of production with all else constant, eventually the MPP will decline
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Fixed costs
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Costs that do not vary with the quantity of output produced
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Variable costs
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costs that vary with the quantity of output produced
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Total cost =
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fixed cost + variable cost
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Marginal Cost
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change in TC / change in Q
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MPP and MC are...
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inversely related
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MC =
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W/MPP
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AP =
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Q/L
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Average fixed cost
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TFC/Q (decrease, gap between AVC and ATC)
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Average Variable Cost
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TVC/Q (increases to close gap between it and ATC)
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Average Total Cost
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TC/Q (parabola)
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ATC =
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AFC + AVC
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When marginal > average
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average rises
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When marginal < average
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average drops
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MC intersects ___ at ____ point.
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ATC, lowest
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Sunk Cost
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incurred in the past, can't be recovered, should not let it affect future decisions
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Long-run average total cost
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The cost per unit of producing each quantity of output in the long run, when all inputs are variable
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Economies of Scale
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when input increases, output increases, and unit cost decreases
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Diseconomies of scale
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when input increases, output decreases, and unit cost increases
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Constant Returns to Scale
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change in input = change in output unit cost is constant
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Minimum Efficient Scale
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lowest cost level where a firm can still produce competitively
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Larger firms have lower unit costs because of...
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1) specialization
2) more money and technology
2) more money and technology
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An increase in technology causes...
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decrease in taxes, decrease in unit costs, decrease in ATC AVC MC
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An decrease in technology causes...
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increase in taxes, increase in unit costs, increase in ATC AVC MC
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Net Benefit =
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total benefit - total costs
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Prioritize _____ over ____.
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marginal benefit, total benefit
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Average Product =
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Q/L
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Marginal Product =
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change in Q/ change in L
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Average product is maximized when...
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AP=MP
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Profit =
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PQ - CQ
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Cost Minimization
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condition for profit maximization, cutting costs, doesn't always work
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Profits are maximized when
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MR=MC
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Cost minimization requires...
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MPl/w = MPk/r
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Slope of budget constraint
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tangent point is the maximization of output (isoquant)
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Minimum Efficient Scale on a graph
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is where economies of scale and constant returns border each other.
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