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# econ chapter 3

question

elasticity

a measure of sensitivity
question
4 types of elasticity

Price Elasticity of Demand

Income Elasticity of Demand

(normal and inferior goods)

Cross-Price Elasticity of Demand (substitutes and complements)

Price Elasticity of Supply

question
Price elasticity of demand

a measure of sensitivity of quantity demanded to change in price

question

Formula for Price elasticity of demand

Ed= % change in Qd / % change in price
question
Demand elasticity affects...

Total Revenue

question
Prices send signals therefore...
Q is a f(P)
question

Formula for TR

TR= P x Q
question
What is the law of demand

as prices increase quantity demand decreases

question
If prices increase will TR increase or decrease?

depends on elasticity

question

2 ways to measure elasticity

1. Point elasticity- you need Calc- NA

2. Arc elasticity- an average between 2 points

question
Elasticity arc formula
% change Q/ % change in P
question
If Elasticity Demand > 1
Demand is elastic or sensitive in a region of elasticity (% change Qd > % change P)
question

If Elasticity Demand < 1

Demand is inelastic or not sensitive in a region of elasticity (% change Qd < % change P)
question

If Elasticity Demand = 1

Demand is unit elastic (% change is = amounts for both)
question

What happens when prices increase, and Demand Elasticity is 1.8

Increase in Price in an elastic region leads to a decrease in TR

- to fix this decrease price in an elastic region and TR will increase

question
What happens when prices increase, and demand elasticity is 3/11

Increase in price in an inelastic regi9on leads to an increase in TR

- therefore, a decrease in price would lead to a decrease in TR

question

Elastic Region

P, TR move in opposite directions

question

Inelastic Region

P, TR move in the same directions

question

1. Increase P in inelastic regions

2. Decrease P in elastic regions

question

Factors affecting Demand elasticity

a. # of substitutes

b. % of Budget Spent on good x

c. Luxury v Necessity

question

Factor 1 affecting DE- # of substitutes

- most important factor

- depends on how you define the market

- RULE: Increase the number of substitutes it increases the elasticity

question

Factor 2 of affecting DE- % of Budget Spent on Good x

- RULE: Increase % Budget Spent on good leads to an increase in elasticity

- Ex. Bananas- small % spent on this therefore little change

-Ex. Cars- large % of budget- more elastic

question

Factor 3 affecting DE- Luxury v Necessity

- Luxuries- more sensitive to change in price- more elastic

- Elasticity of Luxuries > Elasticity of Necessities

question
Factor 4 affecting DE- Time Needed to adjust habits to new situations

- RULE: Increase time- Increase Elasticity

question

Flatter slope of Demand curve=

Increase in elasticity

question

Perfectly elastic=

One price for all Qd

question

Perfectly inelastic

One Q for all Prices

question

Cross Price Elasticity

- relates to substitutes and complements

question

Formula for Cross Price Elasticity

Elasticity xy= % change Q2/ % change P1

- IMP PNT: no numbers added either (+) or (-)

question
Substitutes if...
Increase in P1 --> Increase in Q2, then Exy > 0 OR (+)/(+)
question
Complements if...
Increase in P1 --> Decrease in Q2, then Exy<0 OR (-)/(+)
question

Income Elasticity

- how much the consumption of a good changes with a change in income

question

Formula for Income Elasticity

% change in Consumption / % change in Income

question
Normal good is...
Increase in Income leads to an increase in Consumption- (+)/(+)
question
Inferior good is...
Increase in Income leads to a Decrease in Consumption- (-)/(+)
question

Price Elasticity of Supply

- shows how much Quantity supply changes with a change in price

- same formula as Demand

question

Factors affecting Supply

1. Time necessary to adjust production

2. Excise Taxes

question

Factor 1 affecting Supply- Time necessary to adjust production

- Increase time leads to an increase in elasticity

- ex. increase Q of small cars

question

Factor 2 affecting Supply- Excise Taxes

- Excise tax- a fixed tax per unit sold

- ex. cigarettes, alcohol, gasoline

- causes Supply or Demand to shift in by the amount of the tax

- supply is usually the one that shifts bc it is easier to collect the tax

question
Excise Taxes (continued)

- the shift in supply gives us a new equilibrium price and quantity

- a new equilibrium price is the price consumers pay or Pc

question
TAX=
Pc-Ps
question
Who pays more of the tax consumer or producers?

- depends on elasticity

- the more inelastic party pays more of the tax

- reason: they are less sensitive to changes in price therefore you get a more inelastic curve

question
Max Utility-->

Max Profit

question
Production
how much it costs to produce a certain quantity (Q)
question
TC=

WC + rk

- where W is equal to the wage of L (labor)

- R is equal to the interest rates of K (Capital)

- r represents the opp cost of doing something else with the money

question
TC includes...

opp cost bc. capital includes an opp cost

question

2 Types of Production Costs

1. Short Run

2. Long Run

question

Short Run (SR)

- a time period short enough so that one input cannot be changed

- K cannot be changed in the SR

question
Long Run (LR)
- all variables can be changed (here includes K)
question
Labor (in relation to SR and LR)

- is always variable

- hire/ fire at will

question

Capital

- fixed in the short run

question
Costs in SR
- TC= Total Fixed Costs (TFC) and Total Variable Costs (TVC)
question

Explicit costs

- are out of pocket costs

question

Implicit costs

- opportunity costs of resources owned by the producer

question

Fixed costs can be

explicit or implicit
question
Marginal unit effects...

the average

question
Average Cost or AC=
AFC + AVC
question
AFC=

TFC/Q

- AFC does change with Qty

-TFC does not change with Qty

question
AVC- Average Variable Cost (L)

TVC/Qty

- U- shape graph

-ex. Taco truck with employers

- adding more labor increases efficiency and then decreases efficiency

question

AC- average cost

AVC+AFC
question

Marginal cost

change in TC resulting in the production of one additional unit of output

- only affects labor because we assume capital is fixed

- General idea: Marginal costs pull AVC and AC bc all 3 are related to Labor

question
How MC affects AC

- when MC>AC, then AC increases

- when MC<AC, then AC decreases

question
What dictates the shape of the curves?

- Marginal Productivity of Labor (MPL)

question

Marginal Productivity of Labor

- shows how much output (Q) changes with the addition of one additional unit of Labor

question

law of diminishing returns (to a fixed factor)

- beyond some point successive additions of a variable input which here is L to a fixed unit or K will increase output by increasingly smaller amounts

- your MPL will increase peak and then decrease

- think about the taco truck worker example

question
What is the cost per additional unit of each worker?

MC= Wage/ MPL

question

How to decrease MC

- Decrease wage and decrease MC

- Increase MPL, which leads to a decrease in MC

question
Costs at certain quantity depend on factory size:

they imply an optimum factory size

question

Envelope curve

- a long run Avg cost curve LRAC

- envelopes all possible SRACs

- each contribute 1pt to LRAC

question
Shape of LRAC and SRAC

-SR- U shape due to the Law of Diminishing Returns to a Fixed Factor

-LR- U shape due to Economies of Scale

question

Economies of Scale

is where your LR average cost curve is decreasing as plant output (size) increases

- plant size increases, therefore output increases and LRAC decreases

question

Diseconomies of Scale

as plant size increases your LRAC increases too (opposite of EOS)

question

Factors of Economies of Scale

1. Specialization (increase specialization decrease costs)

2. Mass production techniques

question
factors of diseconomies of scale

-man marginal diseconomies- too large to manage

question

Profit =

total revenue - total cost
question

2 kinds of Profit

1. Accounting profit

2. Economic Profit

question

Accounting Profit

- explicit only

question

Economic Profit

- profit in excess of opportunity cost

- exploit and implicit

question

Function of Profit

- send signals to entrepreneurs

- IDEA: resources should gravitate towards high profit industries

- high profits- attract new entrants

- low profits- companies leave

question
Why is an economic profit of 0 ok?

- you are earning your opportunity cost

question
Free enterprise is...

vital to society

- should be an institution

-entrepreneurs are motivated by profit and competition

- must be compensated for risk and the effort

question

3 pts of entreprenewship

1. Free enterprise is vital to society

question

by profit, therefore there is an incentive to reduce costs and increased efficiency

question

Marginal Profit

change in total profit due to one additional unit

question
marginal revenue

change in total revenue due to the sale of one additional unit

question

Marginal costs

change in cost due to the production of one additional unit

question

Sunk cost

a previously incurred cost that is irreversible
1 of 87
question

elasticity

a measure of sensitivity
question
4 types of elasticity

Price Elasticity of Demand

Income Elasticity of Demand

(normal and inferior goods)

Cross-Price Elasticity of Demand (substitutes and complements)

Price Elasticity of Supply

question
Price elasticity of demand

a measure of sensitivity of quantity demanded to change in price

question

Formula for Price elasticity of demand

Ed= % change in Qd / % change in price
question
Demand elasticity affects...

Total Revenue

question
Prices send signals therefore...
Q is a f(P)
question

Formula for TR

TR= P x Q
question
What is the law of demand

as prices increase quantity demand decreases

question
If prices increase will TR increase or decrease?

depends on elasticity

question

2 ways to measure elasticity

1. Point elasticity- you need Calc- NA

2. Arc elasticity- an average between 2 points

question
Elasticity arc formula
% change Q/ % change in P
question
If Elasticity Demand > 1
Demand is elastic or sensitive in a region of elasticity (% change Qd > % change P)
question

If Elasticity Demand < 1

Demand is inelastic or not sensitive in a region of elasticity (% change Qd < % change P)
question

If Elasticity Demand = 1

Demand is unit elastic (% change is = amounts for both)
question

What happens when prices increase, and Demand Elasticity is 1.8

Increase in Price in an elastic region leads to a decrease in TR

- to fix this decrease price in an elastic region and TR will increase

question
What happens when prices increase, and demand elasticity is 3/11

Increase in price in an inelastic regi9on leads to an increase in TR

- therefore, a decrease in price would lead to a decrease in TR

question

Elastic Region

P, TR move in opposite directions

question

Inelastic Region

P, TR move in the same directions

question

1. Increase P in inelastic regions

2. Decrease P in elastic regions

question

Factors affecting Demand elasticity

a. # of substitutes

b. % of Budget Spent on good x

c. Luxury v Necessity

question

Factor 1 affecting DE- # of substitutes

- most important factor

- depends on how you define the market

- RULE: Increase the number of substitutes it increases the elasticity

question

Factor 2 of affecting DE- % of Budget Spent on Good x

- RULE: Increase % Budget Spent on good leads to an increase in elasticity

- Ex. Bananas- small % spent on this therefore little change

-Ex. Cars- large % of budget- more elastic

question

Factor 3 affecting DE- Luxury v Necessity

- Luxuries- more sensitive to change in price- more elastic

- Elasticity of Luxuries > Elasticity of Necessities

question
Factor 4 affecting DE- Time Needed to adjust habits to new situations

- RULE: Increase time- Increase Elasticity

question

Flatter slope of Demand curve=

Increase in elasticity

question

Perfectly elastic=

One price for all Qd

question

Perfectly inelastic

One Q for all Prices

question

Cross Price Elasticity

- relates to substitutes and complements

question

Formula for Cross Price Elasticity

Elasticity xy= % change Q2/ % change P1

- IMP PNT: no numbers added either (+) or (-)

question
Substitutes if...
Increase in P1 --> Increase in Q2, then Exy > 0 OR (+)/(+)
question
Complements if...
Increase in P1 --> Decrease in Q2, then Exy<0 OR (-)/(+)
question

Income Elasticity

- how much the consumption of a good changes with a change in income

question

Formula for Income Elasticity

% change in Consumption / % change in Income

question
Normal good is...
Increase in Income leads to an increase in Consumption- (+)/(+)
question
Inferior good is...
Increase in Income leads to a Decrease in Consumption- (-)/(+)
question

Price Elasticity of Supply

- shows how much Quantity supply changes with a change in price

- same formula as Demand

question

Factors affecting Supply

1. Time necessary to adjust production

2. Excise Taxes

question

Factor 1 affecting Supply- Time necessary to adjust production

- Increase time leads to an increase in elasticity

- ex. increase Q of small cars

question

Factor 2 affecting Supply- Excise Taxes

- Excise tax- a fixed tax per unit sold

- ex. cigarettes, alcohol, gasoline

- causes Supply or Demand to shift in by the amount of the tax

- supply is usually the one that shifts bc it is easier to collect the tax

question
Excise Taxes (continued)

- the shift in supply gives us a new equilibrium price and quantity

- a new equilibrium price is the price consumers pay or Pc

question
TAX=
Pc-Ps
question
Who pays more of the tax consumer or producers?

- depends on elasticity

- the more inelastic party pays more of the tax

- reason: they are less sensitive to changes in price therefore you get a more inelastic curve

question
Max Utility-->

Max Profit

question
Production
how much it costs to produce a certain quantity (Q)
question
TC=

WC + rk

- where W is equal to the wage of L (labor)

- R is equal to the interest rates of K (Capital)

- r represents the opp cost of doing something else with the money

question
TC includes...

opp cost bc. capital includes an opp cost

question

2 Types of Production Costs

1. Short Run

2. Long Run

question

Short Run (SR)

- a time period short enough so that one input cannot be changed

- K cannot be changed in the SR

question
Long Run (LR)
- all variables can be changed (here includes K)
question
Labor (in relation to SR and LR)

- is always variable

- hire/ fire at will

question

Capital

- fixed in the short run

question
Costs in SR
- TC= Total Fixed Costs (TFC) and Total Variable Costs (TVC)
question

Explicit costs

- are out of pocket costs

question

Implicit costs

- opportunity costs of resources owned by the producer

question

Fixed costs can be

explicit or implicit
question
Marginal unit effects...

the average

question
Average Cost or AC=
AFC + AVC
question
AFC=

TFC/Q

- AFC does change with Qty

-TFC does not change with Qty

question
AVC- Average Variable Cost (L)

TVC/Qty

- U- shape graph

-ex. Taco truck with employers

- adding more labor increases efficiency and then decreases efficiency

question

AC- average cost

AVC+AFC
question

Marginal cost

change in TC resulting in the production of one additional unit of output

- only affects labor because we assume capital is fixed

- General idea: Marginal costs pull AVC and AC bc all 3 are related to Labor

question
How MC affects AC

- when MC>AC, then AC increases

- when MC<AC, then AC decreases

question
What dictates the shape of the curves?

- Marginal Productivity of Labor (MPL)

question

Marginal Productivity of Labor

- shows how much output (Q) changes with the addition of one additional unit of Labor

question

law of diminishing returns (to a fixed factor)

- beyond some point successive additions of a variable input which here is L to a fixed unit or K will increase output by increasingly smaller amounts

- your MPL will increase peak and then decrease

- think about the taco truck worker example

question
What is the cost per additional unit of each worker?

MC= Wage/ MPL

question

How to decrease MC

- Decrease wage and decrease MC

- Increase MPL, which leads to a decrease in MC

question
Costs at certain quantity depend on factory size:

they imply an optimum factory size

question

Envelope curve

- a long run Avg cost curve LRAC

- envelopes all possible SRACs

- each contribute 1pt to LRAC

question
Shape of LRAC and SRAC

-SR- U shape due to the Law of Diminishing Returns to a Fixed Factor

-LR- U shape due to Economies of Scale

question

Economies of Scale

is where your LR average cost curve is decreasing as plant output (size) increases

- plant size increases, therefore output increases and LRAC decreases

question

Diseconomies of Scale

as plant size increases your LRAC increases too (opposite of EOS)

question

Factors of Economies of Scale

1. Specialization (increase specialization decrease costs)

2. Mass production techniques

question
factors of diseconomies of scale

-man marginal diseconomies- too large to manage

question

Profit =

total revenue - total cost
question

2 kinds of Profit

1. Accounting profit

2. Economic Profit

question

Accounting Profit

- explicit only

question

Economic Profit

- profit in excess of opportunity cost

- exploit and implicit

question

Function of Profit

- send signals to entrepreneurs

- IDEA: resources should gravitate towards high profit industries

- high profits- attract new entrants

- low profits- companies leave

question
Why is an economic profit of 0 ok?

- you are earning your opportunity cost

question
Free enterprise is...

vital to society

- should be an institution

-entrepreneurs are motivated by profit and competition

- must be compensated for risk and the effort

question

3 pts of entreprenewship

1. Free enterprise is vital to society

question

by profit, therefore there is an incentive to reduce costs and increased efficiency

question

Marginal Profit

change in total profit due to one additional unit

question
marginal revenue

change in total revenue due to the sale of one additional unit

question

Marginal costs

change in cost due to the production of one additional unit

question

Sunk cost

a previously incurred cost that is irreversible

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