MicroEconomics Exam 1

Markets

Interaction between buyers and sellers

• may be local, national, or international

Price is discovered in the interactions between buyers and sellers

Demand

A schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during specified periods of time

Law of Demand

When other things are equal, as price falls, the quantity demanded rises, and as price rises, the quantity of demand falls

The demand curve

Determinants of demand

• Change in consumer tastes and preferences

• Change in number of buyers

• Change in income

• Change in prices of related goods

• Change in consumer expectations

Law of Supply

When other things equal, as the price rises, the quantity supplied rises and as the price falls, the quantity supplied falls.

Supply Curve

Determinants of Supply

• Change in resource prices

• Change in technology

• Change in number of sellers

• Change in taxes and subsidies

• Change in prices of other goods

• Change in producer expectations

Rationing Function of Prices

The ability of the competitive forces of demand and supply to establish a price at which selling and buying decisions are consistent

Price Ceiling

Price cannot raise to where it needs to be

• Set below equilibrium price

• Rationing problem

• Black markets

• Rent control

Price Floor

• Prices set above the market price

• Chronic surpluses

• minimum wage

Price Elasticity of Demand

Measures the buyers’ responsiveness to price changes

• Elastic demand

• Inelastic demand

Elastic Demand

• Sensitive to price changes

• Large change in quantity demanded

Inelastic Demand

Insensitive to price changes

Small change in quantity demanded

Midpoint Formula

Ensures consistent results of Elasticity

• Inelastic: E_d < 1

• Elastic: E_d > 1

• Unit Elastic: E_d = 1

Absolute value

Total Revenue (TR)

Price x Quantity

Total Revenue test wit Elastic Demand

Elastic Demand: P and TR move in opposite directions

Total Revenue Test with Elastic Demand

Inelastic Demand: P and TR move in same Direction

Substitutability

More substitutes, demand is more elastic

Proportion of income

Higher proportion of income, demand is more elastic

Luxuries Vs. Necessities

Luxury goods, demand is more elastic

Time

More time available, demand is more elastic

Law if 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.

Utility

The satisfaction a buyer will experience when consuming a good or service

Total Utility

Total amount of satisfaction gained

• Sum of all marginal utilities

Marginal Utility

Extra satisfaction from an additional unit of a good or service

Consumer Equilibrium

Consumer allocates his or her income so that the last dollar spent on each product yields the same amount of marginal utility

• Utility maximizing rule

Rational Behavior

Consumers try to use their income to derive the greatest amount of satisfaction, or utility

Preferences

Each consumer has clear-cut preferences for certain goods and services that are available in the market

Budget Constraint

At any point in time the consumer has a fixed, limited amount of income

Prices

Goods are scarce relative to the demand for them, so every good carries a price tag

Income Effect

The impact a price change has on a consumers’ real income

Substitution Effect

The impact a price change has on a product’s relative expensiveness

Economic Cost

The payment that must be made to obtain and retain the services of a resource

• Explicit and Implicit

Explicit Costs

Monetary outlay

Implicit Costs

• Opportunity cost of using self-owned resources

• Includes a normal profit

Accounting Profit

Subtract Explicit costs from Revenue

Economic Profit

Subtract Implicit costs from accounting profit

Short Run

A period where at least one factor of production is fixed (factory size, major equipment, or the number of production facilities)

• Some Variable Inputs (labor hours or raw materials)

• Fixed plant

• A Bakery in the short run might hire more workers or buy more flour, but can't expand its kitchen.

Long Run

A period where all factors of production are variable

• Build new factories, buy or sell equipment, enter or exit the market entirely

• A bakery could now build a second location or install new ovens

Total Product

The total quantity, or total output, of a particular good or service produced

Marginal Product

The extra output or added product associated with adding one unit of a variable resource (such as labor) to the production process.

• change in total product or output / change in labor (or resource) input

Average Product

Also called labor productivity, is output per unit of labor input

• Total Product / Units of labor

Law of Diminishing Returns

Beyond some point, the extra/marginal product of each additional unit of the variable resource will decline. Assumes that:

• Resources are of equal quality

• Technology is fixed

• Variable resources are added to fixed resources

Fixed Costs (TFC)

Costs that do not vary with output

• Rent payments, interest on debt, insurance premiums

Variable Costs (TVC)

Costs that vary with output

• Payment for materials, fuel, power, transportation, labor

Total Cost (TC)

Sum of total Fixed cost and total Variable cost

Economies of Scale

Bring costs down

• Labor specialization

• Managerial specialization

• Efficient Capital

• Other factors

Diseconomies of scale

Drives costs up

• Control and coordination problems

• Communication problems

• Worker alienation

• Shirking

Minimum Efficient Scale (MES)

Lowest level of output at which long-run average costs are minimized

• Can determine the structure of the industry

Natural Monopoly

Long-Run costs are minimized when only one firm produces the product