Microeconomics chapter 6-8

Difference between explicit and implicit costs (example)

Someone puts 100k in a bank earning an interest rate of 5% a year. That's 5k a year. If that person takes out the 100k to start a business, he loses that 5k as an implicit cost. If that person gets a 100k loan instead with a 5% interest rate and he has to PAY 5k at the end of the year, that's an explicit cost.

Marginal rate of substitution

The amount of one good that an individual is willing to give up to obtain an additional unit of another good and maintain equal total utility. Represents the ratio of the marginal utility of the good on the horizontal axis to the marginal utility of the good on the vertical axis MU,good on horizontal axis/MU,good on vertical axis

Income unit elastic

condition that exists when the percentage change in q.d. of a good is equal to the percentage change in income Ey=1

Income elastic

condition that exists when the percentage change in q.d. of a good is greater than the percentage change in income Ey>1

Income inelastic

condition that exists when the percentage change in q.d. of a good is less than the percentage change in income Ey<1

Income elasticity of demand of a good

((change in quantity demanded)/(quantity demanded average))/((change in income)/(income average))

Price elasticity of demand formula

((change in quantity demanded)/(quantity demanded average))/((change in price)/(price average))

Characteristics of indifference curves

1. Indifference curve are downward sloping from left to right. this is because a person has to get more of one good in order to maintain the same level of satisfaction (utility) when giving up some of another good. 2. Indifference curves are convex to the origin. As we move down and to the right along the indifference curve, it becomes flatter. absolute value of the indifference curve slope is called the marginal rate of substitution 3. Indifference curves that are farther from the origin are preferable to those that are nearer to the origin because they represent larger bundles of goods. 4. Indifference curves do not cross (intersect). this is because individuals' preferences exhibit transitivity, which mean if A is preferred to B and B is preferred to C, then A is preferred to C.

Elasticity and tax

Buyers can sometimes pay more half the tax. If the demand for a good is perfectly inelastic, the consumers have to pay the full tax. If the demand for a good is perfectly elastic, sellers have to pay full tax. If supply is perfectly elastic, buyers pay full tax. If supply is perfectly inelastic, sellers pay full tax.

Cross elasticity determinants

Ec>0, the goods are substitutes Ec<0, the goods are complements

Elasticity of demand formula (coefficient)

Ed (coefficient of price elasticity of demand) = (Percentage change in quantity demanded) / (Percentage change in price)

If demand is elastic...

Increase in price=decrease in total revenue. Decrease in price=increase in total revenue.

If demand is inelastic...

Increase in price=increase in total revenue. Decrease in price=decrease in total revenue.

Utility

Measure of the satisfaction, happiness, or benefit that results from the consumption of a good.

Necessities verse luxuries (elasticity determinant)

Necessities=can't live without. Luxuries=can live without. Ex. if price of luxury increases, it's easy to say you don't want to buy it.

Determinants of price elasticity of demand

Number of substitutes, necessities versus luxuries, percentage of one's budget spent on the good, and time.

Total revenue (TR)

Price times quantity sold

Degree of elasticity and tax revenue

The government will choose to place a tax on a seller with an inelastic demand curve rather than an elastic to maximize tax revenues.

Percentage of one's budget spent on the good (elasticity determinant)

The greater the percentage of one's budget that goes to purchase a good, the higher the price elasticity of demand will be. The smaller the percentage of one's budget that goes to purchase a good, the lower the price elasticity of demand will be

Time (elasticity determinant)

The more time that passes (since the price change), the higher the price elasticity of demand for the good will be. The less time that passes (since the price change), the lower the price elasticity of demand for the good will be.

Total utility (TU)

The total satisfaction a person receives from consuming a particular quantity of a good (add up all the utils)

Taxes

When a tax is imposed, the supply curve might shift left which results in a higher price and less supply. This is because sellers have to pay the government that tax but don't want to lose profit.

Explicit cost

a cost incurred when an actual (monetary) payment is made

Implicit cost

a cost that represents the value of resources used in production for which NO actual (monetary) payment is made.

Indifference set

a group of bundles of two goods that give an individual equal total utility. the consumer is indifferent to either good because they give same amount of utility

Number of substitutes (elasticity determinant)

a higher amount of substitutes=higher the price elasticity of demand and vice versa. the more broadly defined the good, the fewer the number of substitutes it will have. the more narrowly defined the good, the more the number of substitutes it will have.

Indifference curve map

a map that represents a number of indifference curves for a given individual with reference to two goods.

Cross elasticity of demand (Ec)

a measure of the responsiveness in quantity demanded of one good to changes in the price of another good. Ec= (percentage change in q.d. of one good)/(percentage change in price of another good). Used to determine whether two goods are substitutes for or complements to each other.

Income elasticity of demand

a measure of the responsiveness of q.d. to changes in income. Ey = (% change in q.d.)/(% change in income) Ey>0, normal good Ey<0, inferior good

Price elasticity of demand

a measure of the responsiveness of quantity demanded to changes in price

Long run

a period during which all inputs in the production process can be varied. (NO inputs are fixed) *long run is not necessarily longer than short runs. long runs just don't have fixed inputs*

Short run

a period during which some inputs in the production process are fixed. most activity happens in the short run

Slope of budget constraint

absolute value of the slope represents the relative prices of the two goods X and Y. If P,y/P,x is 1.25, then the relative price of 1 unit of x is 1.25 units of y.

Budget constraint

all the combinations, or bundles, of two goods a person can purchase, given a certain money income and prices for the two goods. the consumer can afford any combination on or below the budget constraint line

Utils

an artificial construct used to measure utility

Business firm

an entity that employs factors of production (resources) to produce goods and services to be sold to consumers, other firms, or the government

Variable input

an input whose quantity can be changed as output changes

Fixed input

an input whose quantity cannot be changed as output changes

Law of diminishing marginal returns

as ever larger amounts of a variable input are combined with fixed inputs, eventually the marginal physical product (MPP) of the variable input will decline

Marginal product

change in output/change in labor

Interpersonal utility comparison

comparing the utility one person receives from a good, service, or activity with the utility another person receives from the same good, service, or activity.

Fixed costs

costs that do not vary with output; the costs associated with fixed inputs

Variable costs

costs that vary with output; the costs associated with variable inputs

Perfectly elastic demand

demand that occurs when a small percentage change in price causes an extremely large percentage change in quantity demanded (from buying all to buying nothing)

Perfectly inelastic deamnd

demand that occurs when quantity demanded does not change as price changes

Unit elastic demand

demand that occurs when the percentage change in quantity demanded (numerator) is equal to the percentage change in price (denominator). quantity demanded changes proportionately to price changes

Elastic demand

demand that occurs when the percentage change in quantity demanded (numerator) is greater than the percentage change in price(denominator). quantity demanded changes proportionately more than price changes

Inelastic demand

demand that occurs when the percentage change in quantity demanded (numerator) is less than the percentage change in price (denominator). quantity demanded changes proportionately less than price changes

Consumer equilibrium

equilibrium that occurs when the consumer has spent all of his or her income and the marginal utilities per dollar spend on each good purchased are equal: MU,a/P,a=MU,b/P,b=...MU,z/P,z where the letters A-Z represent all the goods a person buys. a person in consumer equil. has maximized total utility

Consumer equilibrium (indifference and budget)

exists at the point where the slope of the budget constraint line is equal to the slope of an indifference curve or where the budget constraint is tangent to an indifference curve. *where they intersect is where the consumer maximizes utility*

Price elasticity of supply (Es)

measure of the responsiveness of quantity supplied to change in price Es>1, elastic supply Es<1, inelastic supply Es=1, unit elastic supply

Diamond-water paradox

observation that things with the greatest value in use sometimes have little value in exchange and things with litter value in use sometimes have the greatest value in exchange.

Average product

output/labor

Marginal utility (MU)

the additional utility a person receives from consuming an additional unit of a good. MU= (change in total utility)/(change in quantity consumed of a good) the change in quantity is usually equal to 1 as total utility rises, MU falls

Marginal physical product (MPP)

the change in output that results from changing the variable input by one unit, with all other inputs held fixed

Marginal cost (MC)

the change in total cost that results from a change in output MC=(change in TC)/(change in output Q)

Indifference curve

the curve that represents an indifference set and that shows all the bundles of two goods giving an individual equal total utility

Profit

the difference between total revenue and total cost *total revenue is price x quantity

Economic profit

the difference between total revenue and total cost (implicit + explicit). usually lower than accounting profit.

Accounting profit

the difference between total revenue and total explicit costs

Law of diminishing marginal utility

the marginal utility gained by consuming equal successive units of a good will decline as the amount consumed increases prices reflect marginal utility, not total utility

Total cost (TC)

the sum of fixed and variable costs TC=TFC+TVC

What changes budget constraints?

the two prices and the individual's income.

Link between MPP and MC

they move in opposite directions. MPP increases then decreases. MC decreases then increases. how the MC curve looks depends on how MPP curve looks

Average total costs

total cost/output

Average fixed costs

total fixed costs/output

Average variable costs

total variable costs/output

Maximizing utility and the law of demand

when price of good a falls, MU,a/P,a>MU,b/P,b, the consumer will then buy more oranges to restore equilibrium the consumer is trying to maximize utility. maximization of utility in consistent with the law of demand.

Normal profit

zero economic profit. the level of profit necessary to keep resources employed in a firm. a firm that earns normal profit is earning revenue equal to its total costs (explicit + implicit) a business can have a positive accounting profit and a zero economic profit