Principles of Economics II Microeconomics Exam Review 2

Long Run Production Costs

- The firm can change all input amounts, including plant size. - All costs are variable in the long run - Long Run ATC

Minimum Efficient Scale (MES) (Not on Review)

- The lowest level of output at which a firm can minimize long-run average total cost - Can determine the structure of the industry

Economic Cost

- The payment that must be made to obtain and retain the services of a resource - The value that people place on a good or service

Price Elasticity of Supply and Time

- Time is primary determinant of elasticity of supply - Time periods considered -- Immediate market period -- Short Run -- Long Run

Utility Maximization Rule

the consumer must get the same amount of utility from the last dollar spent on each good MU of good A/Unit cost of good A = MU of good B/Unit cost of good B

The demand for a product is inelastic with respect to price if (A) consumers are largely unresponsive to a per unit price change. (B) the elasticity coefficient is greater than 1. (C) a drop in price is accompanied by a decrease in the quantity demanded. (D) a drop in price is accompanied by an increase in the quantity demanded.

(A) consumers are largely unresponsive to a per unit price change.

The theory of consumer behavior assumes that (A) consumers behave rationally, attempting to maximize their satisfaction. (B) consumers have unlimited money incomes. (C) consumers do not know how much marginal utility they obtain from successive units of various products. (D) marginal utility is constant.

(A) consumers behave rationally, attempting to maximize their satisfaction.

The larger the positive cross elasticity coefficient of demand between products X and Y, the (A) greater their substitutability. (B) stronger their complementariness. (C) smaller the price elasticity of demand for both products. (D) less sensitive purchases of each are to increases in income.

(A) greater their substitutability.

Suppose the price elasticity coefficients of demand are 1.53, .71, 2.00, and .19 for products W, X, Y and Z, respectively. A 1 percent decrease in price will increase total revenue in the cases of (A) Z and W. (B) W and Y. (C) X and Z. (D) Y and Z.

(B) W and Y.

The law of diminishing marginal utility states that (A) total utility is maximized when consumers obtain the same amount of utility per unit of each product consumed. (B) beyond some point, additional units of a product will yield less and less extra satisfaction to a consumer. (C) price must be lowered to induce firms to supply more of a product. (D) it will take larger and larger amounts of resources beyond some point to produce successive units of a product.

(B) beyond some point, additional units of a product will yield less and less extra satisfaction to a consumer.

Other things equal, an increase in the price of product A will (A) increase the marginal utility per dollar spent on A. (B) decrease the marginal utility per dollar spent on A. (C) not affect the marginal utility per dollar spent on A. (D) cause utility-maximizing consumers to buy more of A.

(B) decrease the marginal utility per dollar spent on A.

The utility of a good or service (A) is synonymous with usefulness. (B) is the satisfaction or pleasure one gets from consuming it. (C) is easy to quantify. (D) rarely varies from person to person.

(B) is the satisfaction or pleasure one gets from consuming it.

Supply curves tend to be (A) perfectly elastic in the long run because consumer demand will have sufficient time to adjust fully to changes in supply. (B) more elastic in the long run because there is time for firms to enter or leave the industry. (C) perfectly inelastic in the long run because the law of scarcity imposes absolute limits on production. (D) less elastic in the long run because there is time for firms to enter or leave an industry.

(B) more elastic in the long run because there is time for firms to enter or leave the industry.

If a firm can sell 6,000 units of a product A at $20 per unit and 10,000 per unit at $16, then (A) the price elasticity of demand is .44. (B) the price elasticity of demand is 2.25 (C) A is a complementary good. (D) A is an inferior good.

(B) the price elasticity of demand is 2.25

Suppose that as the price of Y falls from $2.00 to $1.90, the quantity of Y demanded increases from 110 to 118. Then the absolute value of the price elasticity (using the midpoint formula) is (A) 4.00 (B) 2.09 (C) 1.37 (D) 3.94

(C) 1.37

If a firm's demand for labor is elastic, a union-negotiated wage increase will (A) necessarily be inflationary. (B) cause the firm's total payroll to increase. (C) cause the firm's total payroll to decline. (D) cause a shortage of labor.

(C) cause the firm's total payroll to decline.

If the price of hand calculators falls from $10 to $9 and, as a result, the quantity demanded increases from 100 to 125, then (A) demand is price inelastic. (B) demand is unit elastic with respect to price. (C) demand is price elastic. (D) not enough information is given to make a statement about elasticity.

(C) demand is price elastic.

Prashanth decides to buy a $75 ticket to a particular New York professional hockey game rather than a $50 ticket for a particular Broadway play. We can conclude that Prashanth (A) is relatively unappreciative of the arts. (B) obtains more marginal utility from the play than from the hockey game (C) has a higher "marginal utility-to-price ratio" for the hockey game than for the play. (D) has recently attended several other Broadway plays.

(C) has a higher "marginal utility-to-price ratio" for the hockey game than for the play.

We would expect the cross elasticity of demand between Pepsi and coke to be (A) positive, indicating normal goods. (B) positive, indicating inferior goods. (C) positive, indicating substitute goods. (D) negative, indicating substitute goods.

(C) positive, indicating substitute goods.

In which of the following instances will total revenue decline? (A) Price rises and supply is elastic. (B) Price falls and demand is elastic. (C) Price rises and demand is inelastic. (D) Price rises and demand is elastic.

(D) Price rises and demand is elastic.

If a rational consumer is in equilibrium, which of the following conditions will hold true? (A) MUa = MUb = MUc = . . . = MUn. (B) The marginal utility of each good purchased will be zero. (C) The total utility obtained from each good purchased will be the same. (D) The marginal utility of the last dollar spent on each good purchased will be the same.

(D) The marginal utility of the last dollar spent on each good purchased will be the same.

If the demand for product Y is inelastic, a 4% decrease in the price of Y will (A) decrease the quantity of Y demanded by more than 4 percent. (B) decrease the quantity of Y demanded by less than 4 percent. (C) increase the quantity of Y demanded by more than 4 percent. (D) increase the quantity of Y demanded by less than 4 percent.

(D) increase the quantity of Y demanded by less than 4 percent.

Suppose that MUx/Px exceeds MUy/Py. To maximize utility, the consumer who is spending all her money income should buy (A) less of X only if its price rises. (B) more of Y only if its price rises. (C) more of Y and/or less of X. (D) more of X and/or less of Y.

(D) more of X and/or less of Y.

Assume that a 6 percent increase in income in the economy produces a 3 percent increase in the quantity demanded of good X. The coefficient of income elasticity of demand is (A) negative, and therefore X is an inferior good. (B) positive but less than one; therefore X is an inferior good. (C) positive, and therefore X is an inferior good. (D) positive, and therefore X is a normal good.

(D) positive, and therefore X is a normal good.

Midpoint Fromula

(Qn-Q0) ---------- (Qn+Q0) (--------) ( 2 ) -------------- (Pn-P0) ---------- (Pn+P0 ) (--------) ( 2 )

Natural Monopoly (Not on Review)

- A market that runs most efficiently when one large firm supplies all of the output - A monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms - Long run costs are minimized when only one firm produces the product Example: AT&T a while ago, Some say Amazon

Long Run

- All inputs are variable - Firms can adjust plant size as well as enter and exit an industry

Law of Diminishing Marginal Utility

- As consumption of a good or service increases, the marginal utility obtained from each additional unit of a good or service decreases - Explains downward sloping demand curve

Short Run Production Costs (Not on Review)

- Fixed costs (TFC) - Costs that do not vary with output - Variable costs (TVC) - Costs that do vary with output - Total cost (TC) - Sum of TFC and TVC - TC = TFC + TVC

Implicit Costs

- Indirect, non-purchased, or opportunity costs of resources provided by the entrepreneur - Input costs that do not require and outlay of money by the firm - Opportunity cost of using self-owned resources - Includes a normal profit

Explicit Costs

- Input costs that require an outlay of money by the firm - Monetary Outlay: Cost of labor, land, capital - Costs that require a firm to spend money

Inelastic Demand

- Insensitive to price changes, a small change in quantity - A change in price causes a smaller % change in demand Price and Total Revenue move in the same direction

Utility

- Is the satisfaction one gets form consuming a good or service - Not the same as usefulness - Subjective - Difficult to quantify

The Long Run

- Long run supply is even more elastic than in the short run - More time to adjust/accommodate changes in demand

Income Elasticity of Demand

- Measures responsiveness of buyers to changes in their income - Normal goods if elasticity is positive - Inferior goods if elasticity is negative

Cross Elasticity of Demand

- Measures responsiveness of purchases of one good to change in the price of another good - Substitute goods if elasticity is positive - Complement goods if elasticity is negative - Independent goods if elasticity is 0

Elastic Demand

- Sensitive to price changes, a large change in quantity - A change in price causes a bigger % change in demand Price and Total Revenue move in opposite directions

The Short Run

- Short run supply is more elastic than in the immediate market period

Short Run

- Some variable inputs: A business can adjust their energy used and their labor force - Fixed plant: Plant size cant be changed quickly, can't make the building bigger on a days notice as well as the land size cant be changed

Variable Costs

A cost that changes with the change in volume of activity of an organization. costs that do vary with output

Util

A util is one unit of satisfaction or pleasure

Average Fixed Cost (AFC)

AFC = TFC/Q

Average Total Cost (ATC)

ATC = TC/Q and ATC = AVC + AFC

Average Variable Cost (AVC)

AVC = TVC/Q

Accounting Profit

Accounting Profit = Revenue − Explicit Costs.

Average Product (AP)

Average Product = Total product / Units of labor

Fixed Costs

Costs that do not vary with the quantity of output produced

Interpretation of Elasticity of Demand

Ed > 1 demand is elastic Ed = 1 demand is unit elastic Ed < 1 demand is inelastic Extreme cases Ed = 0 demand is perfectly inelastic Ed = ∞ demand is perfectly elastic

Ed > 1

Demand is elastic (price and total revenue move in opposite directions) Quantity demanded changes by a larger % than does price (Price Increases) = Total Revenue Decreases (Price Decreases) = Total Revenue Increases

Ed < 1

Demand is inelastic (price and total revenue move in the same direction) Quantity demanded changes by a smaller % than does price (Price Increases) = Total Revenue Increases (Price Decreases) = Total Revenue Decreases

Ed = ∞

Demand is perfectly elastic

Ed = 0

Demand is perfectly inelastic

Ed = 1

Demand is unit elastic (perfectly inelastic demand, straight vertical line) Quantity demanded changes by the same % as does price (Price Increases) = Total Revenue is unchanged (Price Decreases) = Total Revenue is unchanged

Economic Profit

Economic Profit = Accounting Profit - Implicit Costs

Economic Profit (summary)

Economic Profit = Revenue - Economic Costs Economic Profit = Revenue - Explicit Costs - Implicit Costs

Price Elasticity of Supply Formula

Es = (%change in quantity supplied of good X) / (%change in the price of good X)

Interpretation of Price Elasticity of Supply

Es > 1 supply is elastic Es = 1 supply is unit elastic Es < 1 supply is inelastic Additionally, Es = 0 supply is perfectly inelastic

Perfectly Elastic Demand Example

Farmer sells corn no reason for a person to buy one corn over another farmers corn. This means the buyer will buy corn from the cheapest seller and not from the highest seller

Elastic supply example

Firms operating below full capacity. If a car factory is operating at 70% capacity, then it can easily increase supply and produce more cars in response to changes in price.

Unit Elastic Example

If I give my son $20 to buy candy, and if he spends the $20 on as much candy as he can get, no matter the price (i.e., he goes to the clerk in the store and says: please give me the amount of candy I can afford for $20), then his demand has unit elasticity: no matter the price, he will spend the $20. If the price goes up by 10%, he will just buy 10% fewer pieces of candy.

Inelastic supply example

Inelastic supply means producers are willing to make products at the same rate regardless of the market price consumers are willing to pay. It would take considerable time to increase the supply of nuclear power because you need skilled labour, and it would take a long time to build.

Inferior Goods E < 0

Inferior goods have a negative income elasticity of demand; as consumers' income rises, they buy fewer inferior goods. Demand falls as income rises A typical example of such type of product is margarine, which is much cheaper than butter.

Perfectly Inelastic Demand Example

Insulin, it is needed to save someones life so they will pay any cost to get it

Marginal Utility

Is the extra satisfaction from an additional unit of the good MU = Change in Total Utility/ Change in Quantity

Total Utility*

Is the total amount of satisfaction

Elastic Demand Examples

Kit Kat candy bar - if the price increases people will find alternatives Gas stations - if one raises the price people will go to the cheapest one.

Marginal Cost (MC)

MC = change in TC / change in Q

Total Product (TP) Marginal Product (MP)

Marginal Product = Change in total product / Change in labor input

Inelastic Demand Examples

Marion owns a grocery store and sells milk, eggs, and grocery goods. Over the past three months, the demand for milk has increased, and Marion decides to raise the price of milk from $10 to $12. What will happen to the quantity demanded? Because the milk is a convenience good, a rise in the price of milk will cause a lower change in the quantity demanded. Marion notices that the quantity demanded declines from 100 to 99. Marion calculates the price elasticity of demand for milk to set a price that can generate a profit to her store.

Normal Goods E > 0

Normal goods have a positive income elasticity of demand; as incomes rise, more goods are demanded at each price level. demand increases as consumers income increases Normal goods whose income elasticity of demand is between zero and one are typically referred to as necessity goods, which are products and services that consumers will buy regardless of changes in their income levels. Examples of necessity goods and services include tobacco products, haircuts, water and electricity. As income rises, the proportion of total consumer expenditures on necessity goods typically declines.

Theory of Consumer Behavior

Rational behavior, preferences, budget constraint, prices the explanation of how consumers allocate incomes to the purchase of different goods and services description of how consumers allocate incomes among different goods and services to maximize their well-being

Es > 1

Supply is elastic Elastic supply means an increase in price causes a bigger % change in supply. It means firms can easily increase supply in response to a change in price.

Es < 1

Supply is inelastic A change in price leads to a smaller percentage change in quantity supplied Inelastic supply means an increase in price causes a smaller % change in supply. It means firms have difficulty increasing supply in response to a rise in price.

Es = 0

Supply is perfectly inelastic The supply curve is vertical; there is no response of demand to prices. Supply is "perfectly inelastic".

Es = 1

Supply is unit elastic

Total Cost (TC)

TC = TFC + TVC

Substitute Goods E > 0

The cross elasticity of demand is always positive because the demand for one good increases when the price for the substitute good increases. Example: if the price of coffee increases, the quantity demanded for tea (a substitute beverage) increases as consumers switch to a less expensive yet substitutable alternative.

Compliment Goods E < 0

The cross elasticity of demand is negative. As the price for one item increases, an item closely associated with that item and necessary for its consumption decreases because the demand for the main good has also dropped. Example: if the price of coffee increases, the quantity demanded for coffee stir sticks drops as consumers are drinking less coffee and need to purchase fewer sticks.

Immediate Market Period

The length of time during which the producers of a product are unable to change the quantity supplied in response to a change in price and in which there is a perfectly inelastic supply.

Perfectly Inelastic Supply Example

There will come a time when we run out of raw materials - oil, natural gas. When this occurs, the supply will be inelastic because it is physically impossible to increase supply.

Total Revenue

Total Revenue = Price x Quantity - Inelastic demand -- P and TR move in the same direction - Elastic demand -- P and TR move in opposite directions

Price Elasticity of Demand

a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price. measures buyers responsiveness to price changes.

Price Elasticity of Supply

a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price Measures sellers' responsiveness to price changes Elastic supply, producers are responsive to price changes Inelastic supply, producers are not as responsive to price changes

Law of Diminishing Returns

as additional increments of resources are added to producing a good or service, the marginal benefit from those additional increments will decline When additional units of a variable input are added to fixed inputs after a certain point, the marginal product of the variable input declines. the principle that, at some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable input to decline -Law of diminishing returns -Resources are of equal quality -Technology is fixed -Variable resources are added to fixed resources -At some point, marginal product will fall -Rationale

Economies of Scale*

factors that cause a producer's average cost per unit to fall as output rises Labor Specialization - Managerial Specialization - Efficient Capital - Other Factors Constant Returns to Scale -

Normal Profit (Not Needed Good to Know)

the payment made by a firm to obtain and retain entrepreneurial ability; the minimum income entrepreneurial ability must receive to induce it to perform entrepreneurial functions for a firm

Constant Returns to Scale

the situation in which a firm's long-run average costs remain unchanged as it increases output

Diseconomies of Scale*

the situation in which a firm's long-run average costs rise as the firm increases output

Long Run Cost Curves

• Differ from short-run cost curves • Much flatter than short-run cost curves