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