MORE econ
What happens to the total amount of consumer surplus in a market if the cost of production rises? The total amount of consumer surplus:
decreases. Fewer goods are sold. The consumer surplus is reduced as a result. The price rises, and that reduces consumer surplus for those goods that are still purchased.
What happens to the total amount of producer surplus in a market if the demand for the product increases? The total amount of producer surplus:
increases. More goods are sold. The producer surplus is increased as a result. The price rises, and that increases producer surplus for those goods that were produced with the original price.
What are costs?
•Accounting profit • •Costs as opportunity costs -Explicit costs -Implicit costs •Economic profit
Production Function
A function showing the maximum output for each specific combination of inputs, given technology.
IMPORTANT
MAXIMIZE PROFIT MR = MC* (P = MC)** *Generally for all markets **For perfect competition
Proft
Maximize profits is firms goal: P = TR -TC
A business should ___________ (increase/decrease) the price of a good with an inelastic demand if it wants to increase revenues
(increase) When demand is inelastic, a change in the price leads to a less than proportional change in quantity, so the effect of the price change is greater than the quantity change. If price increases, revenue increases. If price decreases, revenue decreases.
Total Revenue
-Amount paid by buyers and received by sellers of a good -Price of the good times the quantity sold (P ˣ Q)
Fixed costs
-Costs that do not vary with the quantity of output produced
Variable costs
-Costs that vary with the quantity of output produced
Sunk cost
-Has already been committed, -cannot be recovered, and - should be ignore when making decisions
Taxes placed on seller
-Immediate impact on sellers - shift in supply -Supply curve shifts left -Higher equilibrium price -Lower equilibrium quantity -The tax reduces the size of the market (less quantity) -Taxes discourage market activity -Buyers and sellers share the burden of tax -Buyers pay more •Worse off -Sellers receive less •Effective price (with tax) rises •Worse off
Marginal cost
-Increase in total cost arising from a one unit of production -Marginal cost = Change in total cost when there is a one unit change in quantity -Increase in total cost •From producing an additional (marginal or one) unit of output
•Computing the price elasticity of demand
-Percentage change in quantity demand divided by percentage change in price •Percent change method -Two points: (Q1, P1) and (Q2, P2) (Q2-Q1)/Q1 _________________ (P2-P1)/P1
In your own words, explain how and why changes in prices cause the amounts supplied by producers to change.
A firm is always trying to maximize profit. If prices increase, there is an increased benefit to producing more output. Therefore, firms have an incentive to increase production to earn more profit.
Using your own words, explain why economic profit is much more relevant to decision-making in a business than accounting profit.
A business that earns an accounting profit has revenues that are greater than the costs than it must explicitly pay now or in the future. However, that does not mean that it is earning an actual profit. It may be able to earn even larger accounting profits in another similar business. If it can, then those larger accounting profits that it could earn elsewhere are actual costs. Thus, it is giving up its explicit costs plus a large implicit cost (the profits it could earn elsewhere), which together are greater than its revenues. It is losing in very real terms. If the business used the concept of economic profits, then it should decide to leave its current business.
Assume that competitive firms and a competitive market are in long-run equilibrium. In the short run, what will be the effects of an increase in fixed costs on the output of a typical firm in a competitive market?
A competitive firm will produce where marginal cost and marginal revenue (the market price) are equal. If fixed costs increase, neither marginal revenue nor marginal cost is affected.
Sales taxes are which of the following? A An important source of revenue for state and local governments but not very important for the federal government in the U.S. B An important source of revenue for the federal government but not very important for state and local governments in the U.S. C An important source of revenue for the federal government and state and local governments in the U.S. D Not very important for the federal government nor state and local governments in the U.S. Show Submitted Answer Show Correct Answer Check My Answer
A. Sales taxes make up a large portion of state and local governments' revenue in the U.S., but are not important at the federal level.
diminishing marginal utility
As a consumer purchases more of a good in a specific time period, the additional satisfaction enjoyed from the additional unit of the good will diminish.
If David buys more coffee and less ice cream, the ______________ of coffee will ______________ , and the ___ of ice cream will ______________.
As consumption of a good increases, its marginal utility falls. The reverse is true as well. So if more coffee is consumed, the marginal utility of coffee falls. But as less ice cream is consumed, its marginal utility increases.
Why does the quantity supplied decrease as prices fall?
As the price falls (assuming everything else remains the same), there is less of an incentive to produce goods. Therefore, companies will produce less.
How does diminishing marginal utility affect the decision about how much of a good to purchase compared to another good at the same price?
Because of the law of diminishing marginal utility, the marginal utility of the good purchased will eventually begin to diminish as more and more is purchased. If the marginal utility of the purchased good falls below the marginal utility of other possible purchases that have the same price, the buyer will not buy additional units of the first good, and will instead buy more of the other goods that now have a relatively higher marginal utility. However, not all goods cost the same amount. See if you can work out the logic when prices differ.
In the long run, marginal cost will be _____ average cost if the firm is experiencing economies of scale.
Below. Marginal cost is a short- and long-run concept. It simply represents the cost of increasing production. In the long-run, it assumes all inputs can be varied. In the short-run, not all inputs can be varied. If the firm is experiencing economies of scale, average costs are falling as the firm expands in the long-run. If average costs are falling, marginal costs must be below average costs.
Demand vs. Quantity Demanded
Demand is not the same as quantity demanded. The quantity demanded is how much buyers are willing and able to buy at each specific price. Demand is the whole table, the whole schedule, and the whole curve.
A long-run average cost curve that rises through all levels of possible outputs represents which effect?
Diseconomies of scale. This means that if all inputs are doubled, output will be less than doubled. Thus, the average cost will increase as the scale of the firm increases.
Assume that competitive firms and a competitive market are in long-run equilibrium. What will happen in the long run if fixed costs increase? Firms will ______________ because economic profits have ______________
Exit decrease. In the long run, the market will change. Firms will be earning economic losses (the same as a decrease in economic profits), so some firms will exit. If you were to go beyond that point, you would find the following. As firms leave, the market supply will begin to decrease. This process will continue until a new equilibrium is reached.
When the federal government subsidizes higher education in the form of direct subsidies to universities, it results in:
Explanation The effect of a subsidy directly to the supplier of higher education is a reduction in costs. Anytime there is a decrease in the cost of doing business, supply increases
A business should ___________ (increase/decrease) the price of a good with an elastic demand if it wants to increase revenues.
Explanation (decrease) If demand is elastic, consumers will respond disproportionately to price changes. If price increases, there will be a large effect on demand, outweighing the price increase. If price increases, revenue decreases. If price decreases, quantity will increase by more, increasing revenue.
Total cost
Fixed cost + variable cost
Total variable costs
For a given level of output, the costs (prices multiplied by the amounts of inputs) of the inputs that can be changed. These costs vary as output changes.
As the elasticity of demand increases, all other things being equal, the impact of a tax on equilibrium quantity does which of the following?
Gets smaller. The greater the elasticity of demand, the more quantity demanded will change as the price changes.
If a good has an income elasticity of 0.8, what do you expect to happen to the quantity demanded of this good if the country enters a recession?
If income elasticity is 0.8, then the good is a normal good, meaning that as income increases, so does demand for the good, and if income decreases, demand also falls. If we enter a recession, consumer incomes will fall; therefore, the demand for this good will also fall.
Should firms produce at all?
If price < AVC, then the firm should shut down.If price > AVC, then the firm should produce. 2. If producing, then how much should the firm produce? The firm produces at the output level where MR = MC. Both conditions also apply to all firms in all different types of markets.
Explain in your own words what it means for demand to be elastic or inelastic.
If the percentage change in quantity demanded is greater than the percentage change in price, the ratio of the percentage change in quantity demanded to the percentage change in price is greater than one. The quantity demanded is very sensitive to changes in price, and we describe demand as being elastic. If the percentage change in quantity demanded is less than the percentage change in price, the ratio of the percentage change in quantity demanded to the percentage change in price is less than one. The quantity demanded is less sensitive to changes in price, and we describe demand as being inelastic.
f the price of a normal good decreases, the substitution effect ______________ the quantity demanded of that good.
If the price of a normal good (or any good) falls, there will be a shift toward this good and away from other, relatively more expensive goods according to the substitution effect. Therefore, when the price decreases, the quantity demanded of that good will increase.
If the price of a normal good increases, the income effect ______________ the quantity demanded of that good.
If the price of a normal good increases, there is less real income. With less income, the quantity demanded of normal goods falls.
A consumer is maximizing her satisfaction and currently consuming three goods. If her tastes change so that the marginal utility she gains from movies increases, what will happen to her consumption of the other two goods - hamburgers and football games?
If the ratios of marginal utility to price are equal for all goods, the increase in the marginal utility of movies will mean that the consumer can gain satisfaction by giving up consumption of all other goods and increasing his consumption of movies. As a result of this consumption change, the marginal utility of movies will then decrease and the marginal utilities of the other two goods will increase.
Explain why the marginal utility of water may be quite high at low levels of consumption, but eventually diminish as you increase your consumption.
If you are very thirsty, then that first glass of water will bring you a great deal of satisfaction and happiness. The second glass might continue to increase your satisfaction but probably will not taste as good as that first glass. By the time you get to the fourth glass, you may be struggling to get it down, and the fifth glass might actually cause you distress.
Two facets of taxes that economists often use to compare taxes are _________.
In general, economists most often use the impact taxes have on the efficiency of markets and the fairness of their impact on people.
Compare the effects of a given tax on goods with elastic demands and inelastic demands in terms of amount of revenues raised from the taxes. With an elastic demand, ______ revenue will be raised than with an inelastic demand.
Less. The effects of a tax on a market with an elastic demand will mean a greater decrease in the production of that particular good and thus less overall tax revenue when compared to the same tax in a market with an inelastic (or less elastic) demand.
Profit maximization
In order to maximize profits in a perfectly competitive market, firms set marginal revenue equal to marginal cost (MR=MC). MR is the slope of the revenue curve, which is also equal to the demand curve (D) and price (P). In the short-term, it is possible for economic profits to be positive, zero, or negative. When price is greater than average total cost, the firm is making a profit. When price is less than average total cost, the firm is making a loss in the market. Over the long-run, if firms in a perfectly competitive market are earning positive economic profits, more firms will enter the market, which will shift the supply curve to the right. As the supply curve shifts to the right, the equilibrium price will go down. As the price goes down, economic profits will decrease until they become zero. When price is less than average total cost, firms are making a loss. Over the long-run, if firms in a perfectly competitive market are earning negative economic profits, more firms will leave the market, which will shift the supply curve left. As the supply curve shifts left, the price will go up. As the price goes up, economic profits will increase until they become zero. In sum, in the long-run, companies that are engaged in a perfectly competitive market earn zero economic profits. The long-run equilibrium point for a perfectly competitive market occurs where the demand curve (price) intersects the marginal cost (MC) curve and the minimum point of the average cost (AC) curve
Situation A: When a $10 per unit tax is imposed on the producer of Bippies (a candy), the equilibrium price increases by $4.Situation B: When a $10 per unit tax is imposed on the producer of Bippies, the equilibrium price increases by $2.Based on the two situations above, Bippies in Situation A has a _________ elastic supply OR faces a _________ elastic demand than exists in Situation B.
In situation A, the equilibrium price is higher than in situation B. Therefore, the supply in situation A must be more elastic and/or the demand in situation A must be less elastic than in situation B.
Real income
Income adjusted for price changes. A measure of the amount of goods and services one can purchase.
An increase in the prices of an input will cause long-run average costs to _______.
Increase. Firms were presumably producing in the most efficient way possible given the initial price of inputs. An increase in the price of one of those inputs means that the average cost of any production process is now higher than it was before. Thus, an increase in the price of any input will result in higher average costs. They may use less of that input and more of another, but costs will rise.
In the short run, how will an increase in fixed costs affect the output of a typical firm in a competitive market?
No change in output. A competitive firm will produce where marginal cost and marginal revenue (the market price) are equal. If fixed costs increase, neither marginal revenue or marginal cost is affected.
Are marginal utilities of all goods equal to all other marginal utilities if consumers are maximizing their satisfaction? Explain why or why not.
No. It is the ratio of marginal utilities to prices that are equal. For most people, the marginal utility of an additional Mercedes will be greater than that of an additional plum. But a Mercedes costs much more than a plum, so we need to take into account how much it costs to achieve the additional utility from each. When a dollar "buys" the same amount of satisfaction from each good, then there will be no further incentive to change your buying choices.
Total Revenue
P X Q
Who really pays the tax? Is the elasticity of demand relevant here? What do you expect to be the difference between the elasticity of demand for cigarettes between teenagers and adults?
Regardless of which side of the market is assessed, taxes are shared by both consumers and producers. The more price sensitive one side of the market is, the lower proportion of the tax that side will bear. For example, if consumers are very responsive to price changes (relative to producers), then they will bear less of the tax than producers will. In the case of cigarettes, teenagers probably have a more elastic demand than adults since they may not be as addicted.
Long Run vs short run
Short Run means that there are factors which are fixed, and can not be changed by management. In the Long Run all factors are variable, there are no fixed factors.
If the government imposes an effective price ceiling in a market, what will be the result?
Since this price ceiling is 'effective' this suggests the maximum price is less than the free market equilibrium price. When the price ceiling is below the equilibrium price, it means that the price cannot rise above that level. At the price ceiling, there will be a higher quantity demanded for this good than producers are willing to supply. Therefore, there will be a shortage.
How does an decrease in input costs affect suppliers?
Supply increases: The answer is very similar to the reasoning about firm behavior in response to changes in prices. A decrease in costs (whether it is due to changes in the methods used to manufacture goods or changes in prices of inputs) will increase profits and increase incentives to produce more of the good. Thus a typical business will respond by producing more at each price.
marginal cost
The change in total costs that results from increasing total product by one unit (ΔTC/ΔQ).
marginal utility
The change in total utility or satisfaction resulting from consuming one more unit of a good or service.
The marginal utility from drinking one more glass of water is likely to be ______________ the marginal utility from going to one more movie.
The correct answer really depends upon the relative prices of water and movie tickets. If a glass of water costs less than a movie ticket, a satisfaction-maximizing consumer will have a lower marginal utility gained from water than from movies.
implicit cost
The cost that a business bears by being in its business and not in another business. It is the profit that could be earned elsewhere. It is the opportunity cost.
Total fixed costs:
The costs (prices multiplied by the amounts of inputs) of the inputs that are fixed. This is also the amount of cost when total product is zero. Total fixed costs are costs that do not vary as output changes.
monopolies
The demand in monopoly markets is the same demand competitive markets face. The supply decisions are based on costs for a firm and marginal revenue - a monopoly produces where marginal cost is equal to marginal revenue and then charges a price along the demand curve for that particular quantity. We discussed the point where firms are maximizing profit given the costs they face. Changes in costs and demand will affect production decisions. In the long run, monopolies may earn economic profits while perfectly competitive firms earn normal profits (that is, zero economic profits).
In perfect competition, the demand curve for an individual's firm product is _________.
The demand is horizontal (perfectly elastic) since the firm has no control over the price. They must charge the market price for their good, meaning the firm has zero power to raise their price. If they attempt to raise the price, consumers will all move on to another identical good at a lower price, and that firm will sell nothing. Firms will also not want to lower the price of their good since they can sell as much as they want at the going market price..
When the federal government subsidizes higher education in the form of Pell grants to students, it results in
The effect of a subsidy directly to the consumer is that the effective price of that particular product decreases for the consumer. Therefore, the quantity of higher education demanded at each price would increase with more Pell grants.
Elastic demand
The elasticities of demand and supply affect the extent of the reduction in efficiency due to changes in taxes.
marginal product
The increase in output from using one more unit of an input while all other inputs are constant (ΔTP/ΔL).
If the government taxes car producers, that will happen in the market for cars?
The supply curve will shift to the left.
Total utility
The total amount of satisfaction enjoyed from consuming a specific amount of a good or service
Suppose that there is currently a $2.00 per bottle tax on vodka that is levied on consumers. Legislators have decided to give consumers some relief by eliminating the tax. In order to keep tax revenues at their previous level, they decide to impose a $2.00 tax on producers. What is the net impact of these two actions?
There is no change in either consumers' or producers' well-being.
Question 5.06 If demand were elastic, an increase of 10 percent in the price might cause a 20 percent decrease in quantity demanded. What would happen to the total revenue in this case?
Think of this as an approximation. Revenues rise by 10 percent due to the increase in price and fall by 20 percent due to the lost sales. Thus, total revenues decline. If we do the calculations, one can see that revenues do actually decrease from $20,000 to $17,600. The initial revenues (100 x $200 ) are $20,000. The new lower revenues (80 x $220) are $17,600.
What would happen to the store's total revenue with this 10 percent price increase if quantity falls by 5 percent?
Think of this as an approximation. Revenues rise by 10 percent due to the increase in price and fall by only 5 percent due to the lost sales, that is, the lower quantity. Thus, overall revenues must increase. (And, in fact, if we do the exact calculations, the initial revenue is 100 x $200 or $20,000. If price increases by 10 percent, the new price is $220, and if quantity falls by 5 percent, the new quantity is 95. Therefore, the new revenue is $20,900, an increase of $900 over the initial revenue
Who suffers the greater loss of consumer surplus when the price increases: those with elastic demands or those with inelastic demands?
Those with elastic demand. Because they are more sensitive to price changes, they will reduce their consumption by more than those with an inelastic demand.
Technical efficiency
Using methods to produce goods and services that minimize costs of producing or maximize output given our inputs
Tax on sellers
When a tax of $1.00 is placed on sellers, the supply curve shifts up by $1.00 from S1 to S2. The equilibrium quantity falls from 100 to 90. The price that buyers pay rises from $3.00 to $3.30. The price that sellers receive (after paying the tax) falls from $3.00 to $2.30. Even though the tax is placed on sellers, we find that buyers and sellers share the burden of the tax.
In the long run firms can vary
all units. Labor can be changed in relatively short periods of time and therefore can be easily changed in the long-run also. Capital takes longer and is normally thought capable of being increased only in the long-run. The definition of the long-run is that it is a time period long enough that all inputs can be changed.
Assume that competitive firms and a competitive market are in long-run equilibrium. Assume a constant cost industry. In the short-run, an increase in demand will cause firm output to ______________ and the market price to ______________.
increase, increase: An increase in demand will cause the market price to increase. Thus, the firm's marginal revenue increases. Assuming that the firm was maximizing profits before the change in demand, the price (marginal revenue) must now be greater than the marginal cost. Thus, the firm will increase its output until marginal cost and marginal revenue are once again equal. The firm will still be earning the profits it was before the change in price and it earns additional profits from the increased price and the increased output. Thus, economic profits must rise.
Short run and long run
sr: A time period in which at least one input cannot be changed. lr: a time period long enough that all inputs can be changed In the short and long runs, profit-maximizing businesses will choose the combination of inputs that minimizes the total cost at each level of output. In the long run, that combination will be where the marginal product of each input divided by the price of that input is equal to the marginal product of every other input divided by its price. In the long run, the minimum cost at each level of output is reached by using the size firm where short-run average costs are the lowest at that level of output.
Total surplus
sum of consumer and producer surplus
Average cost
the total cost divided by the total product
average revenue
total revenue divided by the quantity sold
economic profit
total revenue minus total cost, including both explicit and implicit costs
Utility
utility to represent satisfaction gained from consuming a good or service or participating in an activity.
Pricing
•Profit maximization -If MR > MC - increase production -If MC > MR - produce less -Maximize profit •Produce quantity where MR=MC •Intersection of the marginal-revenue curve and the marginal-cost curve •Price - on the demand curve
Tax conclusion
•Taxes placed on sellers and taxes placed on buyers are equivalent -Wedge between the price that buyers pay and the price that sellers receive is the same, regardless of whether the tax is placed on buyers or sellers •Tax burden -Falls more heavily on the side of the market that is less elastic -Small elasticity of demand •Buyers do not have good alternatives to consuming this good -Small elasticity of supply •Sellers do not have good alternatives to producing this good
Market outcomes- social planner
•The benevolent social planner is all-knowing, all-powerful, and well-intentioned dictator. They want to maximize the economic well-being of everyone in society• In market outcomes: Cannot increase economic well-being by -Changing the allocation of consumption among buyers -Changing the allocation of production among sellers •Cannot increase total economic well-being by -Increasing or decreasing the quantity of the good (holding demand and supply curves constant)
Taxes placed on buyers
-Initial impact on the demand -Demand curve shifts left -Lower equilibrium price -Lower equilibrium quantity -The tax - reduces the size of the market -Buyers and sellers share the burden of tax -Sellers get a lower price •Worse off -Buyers pay a higher market price •Effective price (with tax) rises •Worse off
•Computing the price elasticity of supply
-Percentage change in quantity supply divided by percentage change in price
Profit maximization
-Produce quantity where total revenue minus total cost is greatest -Compare marginal revenue with marginal cost •If MR > MC - increase production •If MR < MC - decrease production •Maximize profit where MR = MC • •Note: we found earlier that P=MR (some books will say that P=MC is profit maximum). Since P=MR then we could say P=MR=MC, or MR=MC.
accounting profit
-Total revenue minus total explicit cost -Usually larger than economic profit economic profits are ALWAYS less than accounting profits
Why is there an upward-sloping marginal cost curve?
The firm experiences diminishing marginal product in the short run. With lower marginal product comes higher marginal costs.
Deadweight loss
The loss in consumer and produce surplus less any tax revenue generated from a tax. A measure of the inefficiency created by a tax. It is the difference between what consumers would have been willing to pay for the good or service and the price they have to pay. That difference is lost due to the reduction in production of the good or service. It is equal to the loss in consumer and producer surpluses.
What do you think will happen to marginal utility (that is, the additional satisfaction gained from consuming each additional good) as one consumes more of a good?
The more of something you consume, the less satisfaction another unit will bring you. Sometimes you consume so much of something, that consuming one more will actually lower your overall satisfaction - eating too much pizza, for example!
marginal cost
The opportunity cost of producing one additional unit of output
GDP
•Gross Domestic Product (GDP) -Measures the total income of everyone in the economy -Measures the total expenditure on the economy's output of goods and services •For an economy as a whole -Income must equal expenditure GDP is the market value of all final goods and servises market prices reflect the value of the good
Monopoly
•Monopoly -Firm that is the sole seller of a product without close substitutes •Barriers to entry •Government regulation •Natural monopoly •Monopoly -Price maker -Sole producer -Downward sloping demand •Market demand curve •Competitive firm -Price taker -One producer of many -Demand - horizontal line (Price)
