Price Elasticity & Production, Costs, and Profit

Explicit Cost

Payments made by a business to businesses or people outside of it. Also known as accounting costs These costs include things like payments made for: - wages - buildings - machinery - materials

Perfectly Elastic Supply

Supply for which a product's price remains constant, regardless of quantity supplied

Perfectly Inelastic Supply

Supply for which a product's quantity supplied remains constant regardless of price

Inelastic Supply

Supply for which the percentage change in a product's price causes a smaller percentage change in quantity supplied.

Factors that Affect Price Elasticity of Demand

1. Portion of consumer incomes devoted to buying the product 2. Consumer access to substitutes 3. Whether product is a necessity or luxury 4. The time consumers have to adjust to price changes

Necessities Vs. Luxuries

- Consumers tend to buy similar amounts of necessities, regardless of their price; thus, necessities tend to have inelastic demand. - In contrast, such products as tourist travel, expensive sports cars, and yachts are luxuries that buyers can easily live without. Because these items are expendable, their demand tends to be elastic.

Time

- Demand tends to become elastic over time - In the short run, consumers don't generally respond greatly to price - Over time, however, consumers change their habits and needs.

Access to Substitutes

- If there are many close substitutes for a product, consumers will be more responsive to changes in the product's price because they have more options and can easily change their buying patterns. Example: If only one brand of athletic shoes becomes more expensive, its quantity demanded will plummet as consumers substitute cheaper brands. A rise in the price of all athletic shoes, however, will not radically affect quantities purchased

Short Run

- The period during which the quantity of at least one of the resources used by businesses in an industry cannot be varied - In the case of strawberry farming, a period of less than a single growing season is bound to be a short run. Farmers can use fertilizer but they cannot bring more land into production until the next growing season. The supply curve for the short run may be either elastic or inelastic. This depends on whether a given percentage change in price causes a bigger or smaller variation in quantity supplied.

Inelastic Demand & Total Revenue

- When the demand is inelastic, changes in price have less effect on quantity demanded. - increase in price leads to a smaller percentage decrease in quantity demanded, so total revenue increases. - decrease in price causes a smaller percentage increase in quantity demanded, causing total revenue to fall. - When demand is inelastic, price and total revenue have a direct relationship - total revenue shifts in the same direction as the change in price

Labor-Intensive Process

A process that employs more labor and less capital than do other processes to produce a certain quantity of output. Requires more workers and fewer machines

Elastic Supply

A certain percentage change in the product's price leads to a larger percentage change in its quantity supplied. The quantity that producers are willing to offer for sale is very responsive to price changes.

Unit Elastic Demand

A percentage change in price causes an equal percentage change in quantity demanded - When demand is unit-elastic, a price change leaves total revenue unchanged. (rise in price which causes increase in revenue, is negated by decrease in quantity demanded).

Business

An enterprise that brings individuals, financial resources, and economic resources together to produce a good or service for economic gain. 3 sectors depending on type of production, which all follow the same production principles: - primary - secondary - service (AKA tertiary)

Increasing Cost Industry

An industry that is a major user of at least one resource. A greater quantity supplied leads to an increase in the price of this single resource, such as land or farm machinery.

Constant Cost Industry

An industry that is not a major user of any single resource. Constant Cost industry exhibits a horizontal long-run supply curve.

Price Elasticity & Total Revenue

Demand elasticity plays a role in determining what effect a price change has on total revenue. A rise in a product's price affects the total revenue of businesses selling the product. The higher price, by itself increases the revenue pocketed by sellers, but the accompanying decrease in quantity demanded has the opposite effect.

Elastic Demand

If a given percentage change in price causes a larger percentage change in a product's quantity demanded

Inelastic Demand

If a given percentage change in price causes a smaller percentage change in quantity demanded

Elastic Demand & Total Revenue

If demand for a product is elastic, price changes cause large variations in quantity demanded - price increase of a certain percentage = even bigger percentage decrease in quantity demanded = total revenue is reduced - price decrease of a certain percentage = even bigger percentage increase in quantity demanded,= raising total revenue - when demand is elastic total revenue and price have an inverse relationship - total revenue changes in the opposite direction to the change in price

Portion of Consumer Incomes

If the price of a product represents a hefty portion of consumer incomes, consumers will be more responsive to price changes. The demand for big purchases, tends to be more elastic than the demand for smaller purchases.

Perfectly Inelastic Demand

In contrast, when a product has PERFECTLY INELASTIC DEMAND, its quantity demanded is completely unaffected by price This situation creates a vertical demand curve. Example: Insulin (its essential)

Primary Sector

Includes industries that extract or cultivate natural resources, such as mining, forestry, fishing, and agriculture

Service Sector

Includes trade industries (both retail and wholesale), such as banking and insurance and the new information industries.

Secondary Sector

Involves fabricating or processing goods and includes, among other industries, manufacturing and construction

Productive Efficiency

Making a given quantity of output with the least costly mix of inputs, so at the lowest cost. Selecting the most efficient process, depends both on the quantity of each input used and the prices of these inputs. Owners who want to earn as much profit as possible should try to maximize their businesses productive efficiency. Calculated by: (cost of employee x # of employees) + (cost of machine x # of machines)

Economic Profit

The excess of a business's total revenue over its economic costs. When economic costs are subtracted from total revenue. If this gives a negative figure, the business faces a negative economic profit or a loss. When a business's economic profit is positive, it has reason to continue operating since it's reaping a positive amount after both explicit and implicit costs have been accounted for.

Accounting Profit

The excess of a business's total revenue over its explicit costs profit is found by deducting explicit costs from total revenue.

Factors that Affect Price Elasticity of Supply

The main factor that affects the price elasticity of supply is the passage of time.

Normal Profit

The minimum return necessary for owners to keep funds and their entrepreneurial skills in their business. To calculate normal profit owners must determine the highest possible return they could have received by using their funds and entrepreneurial skills in another way. Another implicit cost is the wages that owners sacrifice by providing labor to the business.

Implicit Cost

The owners opportunity costs of being involved with a business. Implicit costs relate to the resources provided by the owners One implicit cost is normal profit, or the minimum return

Immediate Run

The period during which businesses in a certain industry can make no changes in the quantities of resources they use. In case of strawberry farming the immediate run may be a month. Because quantity supplied is constant, the supply curve is vertical at quantity. Thus the supply is said to be perfectly inelastic.

Production

The process of transforming a set of resources into a good or service that has economic value

Long Run

The quantities of all resources used in an industry can be varied. Also, businesses may enter or leave the industry - In the case of strawberry farming, the long run is a period longer than a single growing season - perhaps as long as a decade. Existing farmers will expand their operations but new farmers will enter the market. Both of these changes increase the quantity supplied of strawberries. 2 results are then possible, depending on what happens to price in the long run at the new higher production levels: 1. if strawberry farming is a constant cost industry, the increase in quantity supplied following a short-run rise in the price of strawberries has no effect on resource prices. 2. the lure of extra profits keeps production expanding, and the price of strawberries falling, until this price is finally driven back to its original level. price is always returned to the same level in the long run, regardless of quantity supplied - so supply is Perfectly elastic. - Supply curve has a positive (upward) slope but is very elastic, showing that quantities supplied are highly sensitive to price changes

Output

The quantity of a good or service that results from production

Inputs

The resources used in production

Price Elasticity of Demand

The responsiveness of a product's quantity demanded to a change in its price Price elasticity of demand is the extent to which consumers (and the quantity they demand) respond to a change in price

Capital-Intensive Process

Uses more capital and less labor to produce the same quantity of output. Requires more machines and fewer workers.

Perfectly Elastic Demand

When a product has PERFECTLY ELASTIC DEMAND, its price remains constant whatever quantities are demanded. Because price never varies, the demand curve is horizontal. Example: Soybean farmer

Economic Costs

a businesses total explicit and implicit costs.

Total Revenue

• Total revenue is defined, either for an individual business or for all businesses producing the same product, as the price of a product multiplied by its quantity demanded