Economics Exam 2
total revenue test with inelastic demand
-Lower price and inelastic demand -Yellow loss exceeds blue gain -a lower price and inelastic demand means that total revenue will fall -Blue gain (extra total revenue from extra sales) is less than the yellow loss (the loss in total revenue from the higher price)
average cost curves
-AFC falls as a given amount of fixed costs is apportioned over a larger and larger output -AVC initially falls because of increasing marginal returns but then rises because of diminishing marginal returns -Average total cost (ATC) is the vertical sum of average variable cost (AVC) and average fixed cost (AFC) -The only difference between the ATC and AVC is the AFC (remember ATC = AFC + AVC or AFC = ATC - AVC), so the vertical distance between the ATC and AVC is the AFC -You want to get used to measuring AFC in this way because at some point the AFC will no longer be included in the graphs
formula for cross elasticity of demand
-Consumption of a good can also be affected by a change in the price of a related good -Cross elasticity of demand provides a way to quantify the degree of the change in consumption.
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.
the long run
-Long-run supply is even more elastic than in the short run -In the long run, there is enough time to adjust output by increasing or decreasing all inputs since all inputs are variable by this time -this means that supply will be even more elastic, and with the same increase in demand, there is an even greater increase in the quantity than in the short run -in the long run, all inputs are variable, even the size of the firm; the firm can expand (reduce) the size of the firm in response to long run price increases (decreases)
total revenue test with elastic demand
-Lower price and elastic demand -Blue gain exceeds yellow loss -A lower price and elastic demand means that total revenue will rise. -Blue gain (extra total revenue from extra sales) exceeds yellow loss (the loss in total revenue from the higher price)
the short run
-Short-run supply is more elastic than in the immediate market period -In the short run, there is enough time to adjust output by increasing or decreasing the variable inputs but not the fixed input -Therefore, supply is more elastic in the short run than in the immediate market period, thereby resulting in a somewhat greater increase in quantity
cross elasticity of demand between education spending and increases in the price of food
-This chart demonstrates the cross elasticity of demand between education spending and increases in the price of foods among selected nations -note that the amount by which education spending falls when food prices go up is higher in lower-income countries than in high-income countries
perfectly inelastic demand
-This extreme situation is called perfectly inelastic demand, and it is very rare -the demand curve would be vertical and graph as a line parallel to the vertical axis -the elasticity coefficient is 0 -an example of a perfectly inelastic demand might be a diabetic's demand for insulin
aircraft and concrete plants
-a commercial aircraft requires large scale production which easily achieves economies of scale and requires few production plants -concrete requires small scale production and therefore there are thousands of plants
price elasticity of demand formula
-absolute changes depend on the choice of units ex: a change in the price of a $10,000 car by $1 is very different than a change in the price of a $1 can of beer by $1 -the auto's price is rising by a fraction of a percent, while the beer's price is rising 100 percent -percentages also make it possible to compare elasticity of demand for different products -because of the inverse relationship between price and quantity demanded, the actual elasticity of demand will be a negative number -however, we ignore the minus sign and use absolute value. This makes it less confusing to interpret the elasticity coefficient
long run
-all inputs are variable -firms can adjust plant size as well as enter and exit industry -long run is a period of time that is long enough for the firm to adjust the plant size as well as enter or leave the industry. All inputs are variable in the long run. One of the primary characteristics of the long run is that it is enough time for firms to enter and exit the industry
market/pricing power
-allows firms to set their product at prices that are in their best interests -for some goods and services, firms may find it advantageous to determine differences in price elasticity of demand and then charge different prices to different buyers
applications of elasticity of supply
-antiques: Inelastic supply (Antiques and other non-reproducible commodities have an inelastic supply; for one-of-a-kind antiques, the supply is perfectly inelastic. This makes their prices highly susceptible to fluctuations in demand. The more inelastic the supply, the greater the change in price when demand changes) -reproductions: More elastic supply (Reproductions, on the other hand, have a much more elastic supply, so the prices tend to remain lower even when there is an increase in demand) -volatile gold prices: Inelastic supply (Gold prices are volatile because the supply of gold is highly inelastic, and unstable demand from speculation causes prices to fluctuate significantly)
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 the downward sloping demand curve -theory of consumer behavior uses the law of diminishing marginal utility to explain how consumers allocate their income
utility-maximizing combination of apples and oranges
-as long as one good provides more utility per dollar than another, the consumer will buy more of the first good; as more of the first product is bought, its marginal utility diminishes until the amount of marginal utility per dollar just equals that of the other product
graphing total and marginal utility
-as more of a product is consumed, total utility increases at a diminishing rate, reaches a maximum, and then declines -marginal utility, by definition, reflects the changes in total utility --> marginal utility diminishes with increased consumption, becomes zero when total utility is at a maximum, and is negative when total utility declines -as shown by the shaded rectangles, marginal utility is the change in total utility associated with each additional candy --> or, alternatively, each new level of total utility is found by adding marginal utility to the preceding level of total utility
marginal cost and marginal product
-assuming that labor is the only variable input and that its price (the wage rate) is constant, then when MP is rising, MC is falling, and when MP is falling, MC is rising -under the same assumptions, when AP is rising, AVC is falling, and when AP is falling, AVC is rising
examples of different consumers paying different prices
-business air travelers --> have more inelastic demand for air travel, so they are charged higher prices since they will pay it -families --> sensitive to prices, so firms will charge lower prices for children as a result of the more elastic demand -students from low income households --> offered assistance with paying for college since they have a higher price elasticity of demand; students from higher income households --> pay full price for their education unless they receive some type of merit-based scholarship
verson stamping machine
-can make as many as 5 million auto parts per year -though the machine is expensive, $30 million, it can make parts quickly and cheaply -this machine is only warranted in factories with very large-scale production -this would be for those companies that can achieve economies of scale by using the low-cost productive machine
rising gas prices
-cause the short-run costs, such as AVC, MC, and ATC, to rise for firms that use this type of energy as an input -as a result, firms like FedEx will see substantial cost increases, whereas firms that do not need to transport products physically will not be affected by the rise in fuel costs
marginal product
-change in total product/change in labor input -the amount that total product changes when labor changes by one unit
global perspective of income elasticity
-chart shows that the income elasticity of gasoline demand varies widely across countries and is larger in lower-income countries
utility maximizing rule and consumer equilibrium
-consumer allocates his or her income so that the last dollar spent on each product yields the same amount of extra (marginal) utility -a consumer is in equilibrium when utility is "balanced (per dollar) at the margin" -we have to find the marginal utility per dollar by dividing the marginal utility of the good by the price of the good
formula for income elasticity of demand
-consumption of a good can also be affected by a change in income -income elasticity of demand is a measurement that reflects the percentage change in quantity demanded/some percentage change in consumer income
advertising revenue
-daily newspapers have experienced decreases in advertising revenues, falling subscriptions, and increases in their AFC -advertising revenue has shifted to the Internet and daily newspapers may be a thing of the past -if they raise the price of the newspaper, they will sell fewer papers, but then the AFC rises too
MES and industry structure 1
-this is a long-run ATC curve showing industries with an extended range of constant returns to scale -these industries will be populated by firms of many different sizes -small- and large-scale producers will coexist and be equally successful. MES occurs at an output of q1
3D printers
-first industrial revolution began in 1700s -mass production led to mass affordability -second industrial revolution began in late 1800s -mass sales were necessary to spread R&D costs -third industrial revolution beginning now -affordable mass customization (3D printers are inexpensive) with zero transportation costs
successful start-up firms
-have been successful by lowering their ATC as they increased output and achieved economies of scale -this spreads out R&D and advertising costs over a larger number of units -some examples of these types of firms are Starbucks, Microsoft, and Google
income elasticity insights
-high income elasticities: most affected by a recession -low or negative income elasticity: not affected that much by a recession *income elasticity helps us understand which products and industries will be most affected when household incomes fall during economic downturns
MES and industry structure 2
-industries with economies of scale over a wide range of outputs will lead to a few large-scale firms. Small firms cannot realize the minimum efficient scale and will not be able to compete -the long-run ATC curve is lowest only when there is a large output
inelastic demand
-insensitive to price changes -small change in quantity demanded -when demand is inelastic, there is a very small change in quantity demanded even when there is a large change in price
utility
-is the satisfaction one gets from consuming a good or service •Not the same as usefulness --> items that are useless can provide utility •Subjective •Difficult to quantify
applications of price elasticity of demand
-large crop yields: Inelastic demand, lower total revenue (supply of crops increases and shifts to the right. When this occurs, the equilibrium price falls. Since demand is inelastic, the lower price leads to lower revenue for farmers. Farmers are worse off when there is a large crop yield) -excise taxes: Inelastic demand, more total revenue ( If they place a tax on a good with an inelastic demand, the higher price won't decrease the quantity purchased by much, thereby increasing the amount of tax revenue that government collect) -decriminalization of illegal drugs: Inelastic demand, more total revenue (If heroin and cocaine were legalized, their prices would decline according to proponents of legalization. Demand for illegal drugs like this are inelastic for a drug addict, so if the price dropped, the amount consumed at that lower price wouldn't change by much. Crime would subsequently decline since the addicts wouldn't need to steal as much to support their habit. Opponents of legalization say that lower prices for these drugs would simply increase the quantity demanded for them and not benefit society at all)
natural monopoly
-long-run costs are minimized when only one firm produces the product -a natural monopoly is a rare situation where economies of scale extend beyond the market size. Therefore, one large firm can provide the product more cheaply than a multi-firm market
total revenue test with unit-elastic demand
-lower price and unit-elastic demand. Blue gain equals yellow loss. -a lower price and unit-elastic demand means that total revenue is unchanged -blue gain (extra total revenue from extra sales) is exactly equal to the yellow loss (the loss in total revenue from the higher price)
luxury and time
-luxuries versus necessities: Luxury goods, demand is more elastic (Since luxuries are goods that consumers can go without, they will change the amount they purchase by a greater amount, even if the price changes by a small amount) -time: More time available, demand is more elastic (It takes time to alter the amount being purchased, so the more time available, the more elastic the demand. A person doing his or her Christmas shopping on Christmas Eve has a very inelastic demand because he or she doesn't have the time to look around for alternative purchases)
diseconomies of scale
-may occur if a firm becomes too large, as illustrated by the rising part of the long-run ATC curve -as the firm expands over time, the expansion may lead to higher average total costs -with diseconomies of scale, an increase in inputs will cause a less than proportionate increase in output •Control and coordination problems •Communication problems •Worker alienation •Shirking
income elasticity of demand
-measures responsiveness of buyers to changes in their income -normal goods --> elasticity is positive -inferior goods --> elasticity is negative (consumers decrease their purchases of inferior goods when their income rises) *Those industries with products that are income elastic will expand at a higher rate as the economy grows
cross elasticity of demand
-measures responsiveness of purchases of one good to change in the price of another good (Cross elasticity of demand refers to the effect of a change in a product's price on the quantity demanded for another product) -substitute goods if elasticity is positive (If the goods are substitutes, they will have a positive cross elasticity of demand since the change in the price of one good and the change in the demand for its substitute move in the same direction) -complementary goods if elasticity is negative (If the goods are complements, they will have a negative cross elasticity of demand since the change in the price of one good and the demand for its complement move in opposite directions) -independent goods if elasticity is zero or near-zero (If the goods are unrelated, they will show a cross elasticity of zero)
price elasticity of supply overview
-measures sellers' responsiveness to price changes. -elastic supply, producers are responsive to price changes -inelastic supply, producers are not as responsive to price changes (At higher prices, firms are willing and able to produce more, whereas at lower prices, firms are willing and able to produce less. Price elasticity of supply measures how sensitive firms are to price changes. If supply is elastic, small changes in price will result in firms greatly altering the quantity being produced. On the other hand, when supply is inelastic, the firm is unresponsive to price changes and therefore will not change the amount being produced by much, even when the change in price is large)
explicit costs
-monetary outlay -payments to non-owners for resources they supply. In the textbook's T-shirt example, this would include the cost of the T-shirts, clerk's salary, and utilities, for a total of $63,000
total revenue test example
-notice that in the high-price region, demand for movie tickets is elastic, and revenues increase as price falls -midway demand for movie tickets is unit elastic, and revenues stay the same as price falls -in the low-price region, elasticities of demand are inelastic, and revenues fall as the price falls -the first graph shows the relationship between price elasticity of demand for movie tickets and total revenue -demand curve D is based on Table 6.1 and is marked to show that the hypothetical weekly demand for movie tickets is elastic at higher price ranges and inelastic at lower price ranges -the total-revenue curve, TR, is derived from demand curve D in the first graph. When price falls and TR increases, demand is elastic; when price falls and TR is unchanged, demand is unit elastic; and when price falls and TR declines, demand is inelastic
constant returns to scale
-occur when ATC is constant over a variety of plant sizes -when there are constant returns to scale, an increase in inputs will result in a proportionate increase in output
implicit costs
-opportunity cost of using self-owned resources -includes a normal profit -the monetary payments the self‑employed resources could have earned in their best alternative employment. In the textbook's T-shirt example, this would include forgone interest, forgone rent, forgone wages, and forgone entrepreneurial income, for a total of $33,000
price elasticity of supply formula
-percentage change in quantity/percentage change in price-elasticity of supply will always be positive since price and quantity supplied move in the same direction
the immediate market period
-perfectly inelastic supply -In the immediate market period, there is no time for sellers to adjust to a price change, making supply perfectly inelastic -with a perfectly inelastic supply, the increase in demand does not change the quantity demanded at all
rational behavior
-preferences -the assumption that the consumer tries to use his or her money income to derive the greatest satisfaction from it -Each consumer has clear cut preferences for certain goods and services available in the market and has some idea of how much marginal utility they might get from purchasing and consuming additional units
budget constraint
-prices -at any point in time the consumer has a limited, fixed amount of money to spend -every good has a price and prices are unaffected by amounts purchased by the consumer. Goods and services have prices and are scarce relative to the demand for them
economies of scale
-refers to the idea that, for a time, larger plant sizes will lead to lower unit costs -an increase in inputs where there are economies of scale will lead to a more than proportionate increase in output •Labor specialization •Managerial specialization •Efficient capital •Other factors
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 -at some point there will be so much labor that the fixed resources are overutilized and the individuals will have to wait to use the necessary equipment. This is where we might see diminishing marginal returns—where the TP is still increasing when hiring one more unit of labor, but it doesn't increase as much as it did with the previous unit of labor
elastic demand
-sensitive to price changes -large change in quantity demanded -If demand is elastic, there is a large change in quantity demanded even when price changes by a small amount
perfectly elastic demand
-this extreme situation, in which a small price reduction would cause buyers to increase their purchases from zero to all that is possible to obtain, is perfectly elastic demand, and the demand curve would be horizontal -the elasticity coefficient is infinite -an example of a perfectly elastic demand is a firm's demand curve in a purely competitive industry, such as the mining industry, that is unable to change the price
marginal cost curve to average-total-cost and average-variable-cost curves
-shifts in the curves will occur if either resource prices or technology change -when MC is below average variable cost, AVC falls; when MC is above average variable cost, AVC rises -marginal decisions are very important in determining profit levels. In order to make marginal decisions, marginal revenue and marginal cost are compared -marginal cost is a reflection of marginal product and diminishing returns -when diminishing returns begin, the marginal cost will begin its rise
applications of cross elasticity of demand
-should a company change a price? (Companies can use cross-price elasticity to determine whether raising the price of one of their products will affect sales of another of their products) -should the government allow a merger? (Government can use it to determine whether to allow a proposed merger of two companies or not. If there is a high cross-price elasticity between the two companies' products, the government will likely not allow the merger)
short run
-some variable inputs -fixed plant -a period of time that is too brief for a firm to alter its plant capacity, but during which the firm can change output somewhat by increasing or decreasing its variable inputs
substitutability and proportion of income
-substitutability: More substitutes, demand is more elastic (With more substitutes available, consumers have more alternative options, so when there is a change in price, there is a greater percentage change in quantity demanded, making the demand more elastic. The broader the definition of the market, the more elastic the demand. With a narrower definition of the market, demand is more inelastic) -proportion of income: Higher proportion of income, demand is more elastic (The greater the proportion of income needed to buy the good, the more elastic the demand. Consumers will be more sensitive to changes in prices because the price change can result in thousands of dollars difference)
criminal behavior
-the criminal attempts to maximize his or her total utility -compares the marginal benefit with the marginal cost of the unlawful activity -most people find the costs too high -for others, society imposes additional costs such as fines and imprisonment -potential to reduce crime by increasing the cost of crime
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: Now consider costs in terms of average total costs -an industry and the individual firms that are in it can make all desired resource adjustments in the long run -all resources are variable; therefore all costs are variable in this time period.
applications and extensions
-the first touchscreen tablet computer, the iPad, was a new product enormously popular with consumers and perceived by them as having a greater marginal utility to price ratio than other alternative products --> this resulted in a major shift in demand for the new product as consumers attempted to increase their total utility -why do some goods that are essential to life have low prices and goods that are not essential to life have high prices? --> the marginal utility of the last unit of water consumed is small because we consume a lot of water -the marginal utility of the last diamond is large because we consume few diamonds -noncash gifts may yield less utility to the receiver than a cash gift of equal monetary value because the noncash gift may not match the receiver's preferences -individuals know their own preferences better than the gift giver
income effect
-the impact a price change has on a consumer's real income and quantity demanded of the good -the income effect is shown by the fact that a decline in price expands the consumer's real income and the consumer can purchase more of this and other products until equilibrium is once again attained for the new level of real income
substitution effect
-the impact a price change has on a product's relative expensiveness and on quantity demanded -when the price of an item declines, the consumer will no longer be in equilibrium until more of the item is purchased and the marginal utility of the item declines to match the decline in price --> more of this item is purchased rather than another relatively more expensive substitute
long-run cost curve
-the long-run ATC curve just "envelopes" the short-run ATCs -if the number of possible plant sizes is very large, the long-run average-total-cost curve approximates a smooth curve -economies of scale, followed by diseconomies of scale, cause the curve to be U-shaped
firm size and costs
-the long-run average-total-cost curve is made up of segments of the short-run cost curves (ATC-1, ATC-2, etc.) of the various-size plants from which the firm might choose -the long-run cost curve is also called the planning curve -each point on the bumpy planning curve shows the lowest unit cost attainable for any output when the firm has had time to make all desired changes in its plant size
economic cost
-the payment that must be made to obtain and retain the services of a resource -the payments a firm must make, or incomes it must provide, to resource suppliers to attract those resources away from their best alternative production opportunities. Payments may be explicit or implicit (recall the opportunity-cost concept)
Quantitative measure of elasticity
-the percentage change in the quantity demanded of X over the percentage change in price of product X
total utility
-the total amount of satisfaction one gets from the consumption of a single product or a combination of products -total utility can be derived by adding up the utils of successive units consumed
price elasticity of supply and time
-time is primary determinant of elasticity of supply (The ease of shifting resources between alternative uses is very important in price elasticity of supply because it will determine how much flexibility a producer has to adjust its output to a change in the price) -time periods considered: •Immediate market period --> The immediate market period means that there is no time to adjust output in response to a price change. Some industries may not have an immediate market period if they are able to store their product •Short run --> The short run means that there is enough time to adjust output by increasing or decreasing the variable inputs but not the fixed inputs. •Long run --> The long run means that there is enough time to adjust output by increasing or decreasing all inputs
total revenue test overview
-total Revenue = Price × Quantity -total Revenue Test Inelastic demand: P and TR move in the same direction Elastic demand: P and TR move in opposite directions -The total-revenue test is the easiest way to judge whether demand is elastic or inelastic -this test can be used in place of the elasticity formula, unless there is a need to determine the elasticity coefficient. The total revenue test is important for understanding the relationship between price elasticity and total revenue -demand is inelastic if a decrease in price results in a decrease in total revenue or if an increase in price results in a rise in total revenue -demand is elastic if a decrease in price results in a rise in total revenue or if an increase in price results in a decline in total revenue -demand is unit elastic if total revenue does not change when the price changes
short run cost curves
-total cost is the sum of total fixed cost and total variable cost.
average product
-total product/units of labor -output that is produced per unit of labor
total product
-total quantity that is produced
midpoint formula
-using traditional calculations, the measured elasticity over a given range of prices is sensitive to whether one starts at the higher price and goes down or starts at the lower price and goes up -the midpoint formula calculates the average elasticity over a range of prices to avoid that problem.
marginal utility
-utility refers to the extra utility a consumer gets from one additional unit of a specific product -in a short period of time, the marginal utility derived from successive units of a given product will decline --> (this is known as diminishing marginal utility) MU = ΔTU/ΔQ
minimum efficient scale (MES)
-where MES occurs on an industry's long-run ATC determines if there will be many or few producers and whether they will be large, small, or different sizes •Lowest level of output at which long-run average costs are minimized. •Can determine the structure of the industry.
economic profit
= accounting profit - implicit costs or = revenue - explicit costs - implicit costs
accounting profit
= revenue - explicit costs -always higher than economic profit
per-unit, or average, costs
Average fixed cost (AFC) = TFC/Q Average variable cost (AVC) = TVC/Q Average total cost (ATC) = TC/Q Marginal cost (MC) = ΔTC/ΔQ
interpretation of elasticity of demand
Ed > 1 demand is elastic. Ed = 1 demand is unit elastic (the % change in price and % change in quantity are exactly equal) Ed < 1 demand is inelastic. Extreme cases: •Ed = 0 demand is perfectly inelastic (Perfectly inelastic demand means that consumers will buy exactly the same amount no matter how high or low the price) •Ed = ∞ demand is perfectly elastic (Perfectly elastic demand means that nothing will be purchased if there is any deviation from the current price)
short run production costs
Fixed costs (TFC): Costs that do not vary with output. (ex: rental payments, insurance premiums) Variable costs (TVC): Costs that do vary with output. (fuel, power, labor) Total cost (TC): •Sum of TFC and TVC •TC = TFC + TVC
