Economics Profit Maximization Test

elastic good

When a change in price of a good causes a large change in quantity demanded

inelastic good

When a change in price of a good causes only a small change in quantity demanded

Price elasticity of demand (PED)

how much quantity demanded changes in response to a change in price

Always measured between two points on a demand curve → There is “PED of points A and B” but there is no such thing as “the PED at point A"

If PED is greater than one, the good is…

elastic

If PED is less than one, the good is…

inelastic

If PED is equal to one, the good is…

unit elastic

Midpoint Method (Allows you to find PED and determine if a good is elastic, inelastic, or unit elastic)

Subtract Q2-Q1 and find the midpoint between Q2 and Q1.

Subtract P2-P1 and find the midpoint between P2 and P1.

PED= Q difference/Q midpoint / P difference/P midpoint

*All numbers here are absolute value, NO negative numbers!

What factors determine whether a good is usually inelastic or elastic?

Goods with substitutes are elastic. Ex: if the price of butter rises, it will cause a large decrease in quantity demanded for butter because people can now buy margarine which is cheaper.

Necessities vs. Luxuries → Necessities are inelastic whereas Luxuries are elastic

Broad or Narrow Markets → Broad categories of markets (food, dessert, books) are inelastic. Narrow categories of markets (apples, vanilla ice cream, romance novels) are elastic.

Time Horizon → Goods are more elastic over longer time spans. Ex: If gas prices go up over a few months, quantity demanded decreases only slightly, but if they continue to go up over the years, quantity demanded decreases by a larger amount as people will buy alternatives, such as hybrids.

Total revenue

The amount paid by buyers and received by sellers of a good.

TR= P*Q

If PED is inelastic, a price increase leads to a total revenue _____ and a price decrease leads to a total revenue _____

increase, decrease

If PED is elastic, a price increase leads to a total revenue _____ and a price decrease leads to a total revenue _____

decrease, increase

If PED is unit elastic, a price increase or decrease _____total revenue

does not change

marginal product

the increase in output from an additional unit of input

EXAMPLE: If I hire 1 more worker, how many additional products will be produced each day?

diminishing marginal product

when the marginal product of an input declines as the number of inputs increases

At first, adding more workers or resources can increase output a lot, but after a point, each additional worker adds less and less to total production. As you keep adding more workers, they have to share the same tools, equipment, or workspace.

Eventually, they start getting in each other’s way or run out of productive tasks.

This reduces the effectiveness (or productivity) of each additional worker.

marginal cost

the increase in total cost from producing 1 more of a product

EXAMPLE:

The NFL produces 499 Patriots jerseys at a total cost of $500. To produce 500 jerseys the total cost will be $502. What is the marginal cost? →$2

Production function

the relationship between the quantity of inputs to make a good and the quantity of good produced 

X-axis: Inputs(labor and capital). Capital is the tools used to produce a good

Y-axis: Output(the quantity produced)

Total cost curve

The relationship between a company’s total cost and quantity produced

X-axis: quantity produced (notice its flipped from production function)

Y-axis: Total cost

total cost

fixed costs + variable costs = total cost

fixed costs

costs that do not vary with the quantity of output produced 

Ex: the rent paid by a factory, payment for workers with fixed salaries

variable costs

costs that do vary with the quantity of output produced

Ex: cost of paper for a publishing company, costs of hiring workers to increase quantity produced

average total cost

total cost divided by quantity of output ATC= TC/Q

average fixed cost

fixed costs divided by quantity of output AFC= FC/Q

average variable cost

variable costs divided by quantity of output AVC= VC/Q

Total cost is _______ cost and _______ cost added together

fixed, variable

average total cost is _______ and ______ added together

average fixed cost, average variable cost

marginal revenue

how much is earned from selling one additional good

ALWAYS equal to price

2 equations to find TC from ATC

ATC=TC/Q and TC=ATC*Q

Equation for finding marginal profit

Marginal profit=Marginal Revenue (MR) - Marginal cost (MC)

Equation for finding profit

Profit= revenue-cost