Elasticity, Costs, and Profit (Exam 2)

A set of practice Q&A flashcards covering elasticity concepts (perfectly elastic/inelastic, elastic ranges, total revenue effects), income and cross-price elasticity, consumer choice and marginal utility, and cost and production theory (short run vs long run, MP, AP, cost curves, and profit concepts) as presented in the lecture notes.

What does the price elasticity of demand measure?

How responsive consumers are to changes in price.

What is elastic demand?

Demand in which the percentage change in quantity demanded is greater than the percentage change in price; consumers are highly responsive.

What is inelastic demand?

Demand in which the percentage change in quantity demanded is smaller than the percentage change in price; consumers are less responsive.

What is a perfectly elastic demand curve?

A horizontal demand curve; an infinitesimally small change in price leads to an infinitely large change in quantity demanded.

What is a perfectly inelastic demand curve?

A vertical demand curve; quantity demanded does not change as price changes.

Why is price elasticity of demand treated as a magnitude rather than a sign?

Because demand is downward sloping, elasticity is negative; the sign is ignored to focus on the size of responsiveness.

What are the three elasticity ranges on a downward-sloping demand curve?

Elastic (>1), Unit elastic (=1), and Inelastic (<1) elasticity.

Where on the demand curve is the elastic range typically located?

The upper portion of the downward-sloping demand curve.

What is the unit elastic point?

The point where elasticity equals 1; total revenue is maximized there.

What happens to total revenue when price increases in the elastic range?

Total revenue decreases.

What happens to total revenue when price decreases in the elastic range?

Total revenue increases.

What happens to total revenue when price increases in the inelastic range?

Total revenue increases.

What happens to total revenue when price decreases in the inelastic range?

Total revenue decreases.

What does the unit elastic point signify for total revenue?

Total revenue is maximized at the unit elastic point.

What is cross-price elasticity?

The percentage change in quantity of good X divided by the percentage change in price of good Y.

What does a positive cross-price elasticity indicate?

The two goods are substitutes.

What does a negative cross-price elasticity indicate?

The two goods are complements.

What is income elasticity?

The percentage change in quantity demanded divided by the percentage change in income.

What does a positive income elasticity imply?

The good is a normal good.

What does a negative income elasticity imply?

The good is an inferior good.

What is the difference between accounting profit and economic profit?

Accounting profit = total revenue minus explicit costs; economic profit = total revenue minus explicit and implicit costs.

What is normal profit?

Zero economic profit; the business earns just enough to cover opportunity costs.

What are fixed costs?

Costs that do not vary with output (e.g., rent, advertising).

What are variable costs?

Costs that vary with output (e.g., labor, materials, electricity).

What is total cost (TC)?

FC + VC (fixed cost plus variable cost).

What are AFC, AVC, and ATC?

AFC = fixed cost divided by quantity; AVC = variable cost divided by quantity; ATC = total cost divided by quantity (or AFC + AVC).

Where do MC, ATC, and AVC intersect?

MC intersects ATC and AVC at their minimum points.

What is marginal cost (MC)?

The change in total cost divided by the change in quantity (often ΔTC/ΔQ).

What is the short run in production theory?

At least one input (capital) is fixed; only labor can vary in the short run.

What is the long run in production theory?

All inputs are variable; firms can adjust capital and scale.

What is the marginal product of labor (MPL)?

The change in total product divided by the change in labor; the extra output from an additional worker.

What is diminishing marginal returns?

As more units of a variable input are added to a fixed input, marginal product eventually declines.

What is the average product of labor (APL)?

Total product divided by the number of workers.

What are fixed costs, variable costs, and total cost in the Taco Bell example?

FC is constant (e.g., rent); VC increases with output (e.g., labor, materials); TC = FC + VC.

How do you compute average fixed cost (AFC)?

AFC = FC / quantity; it declines as output increases.

What is the formula for average total cost (ATC)?

ATC = TC / Q (or ATC = AFC + AVC).

What is the profit-maximizing rule in terms of marginal concepts?

Produce where marginal revenue equals marginal cost (MR = MC).

What is the meaning of the three questions all firms must answer?

How much output to supply, how to produce the output, and how much of each input to use.

What is the cereals case in brief?

An antitrust case where three big cereal companies were sued for monopolistic power; the government lost because there are substitutes; consumers have alternatives.

What is a key consumer choice rule demonstrated in the Billy example?

Allocate spending so the last dollar spent on each good provides the same marginal utility per dollar (MUx/Px = MUy/Py).