SFM 1O2

Week 1-3

demand

the amount of some good or service consumers are willing and able to purchase at each price

quantity demanded

the amount of a good or service that a consumer is willing and able to purchase at a given price

law of demand

the inverse relationship between price and quantity demanded — as price increases, quantity demanded decreases; as price decreases, quantity demanded increases

demand curve

a graph of the relationship between the price (y

demand curves usually slope ...

down from left to right

what causes movement along a supply/demand curve?

change in price

factors that shift the demand curve

1. income
2. price of related goods
3. expectations of future prices
4. tastes and preferences

normal goods

goods for which demand goes up when income is higher and goes down when income is lower

inferior goods

goods for which demand goes down when income rises

if demand/supply increases, the curve shifts to the ...

right

if demand/supply decreases, the curve shifts to the ...

left

substitute goods

goods that can serve as replacements for one another — an increase in price for one would increase the demand for the other

complement goods

goods that are often used together; consumption of one good tends to enhance the consumption of the other — a decrease in price for one would increase the demand for the other

supply

the amount of some good or service a producer is willing to supply at each price

law of supply

a higher price results in a higher quantity supplied and a lower price leads to a lower quantity supplied

supply curve

a graph of the relationship between the price (y

supply curves usually slope ...

upward from left to right

factors that shift the supply curve (5)

1. changes in production costs
2. technology
3. taxes
4. input prices
5. prices of related goods & services

equilibrium

when quantity supplied \= quantity demanded; @ equilibrium, there is no tendency for the market price to change

surplus

the situation when quantity SUPPLIED exceeds (\>) the quantity demanded — occurs at any above

shortage

the situation when quantity DEMANDED exceeds (\>) the quantity supplied — occurs when the price is below equilibrium

changes in market equilibrium: decreases in demand & supply

leads to a lower equilibrium quantity &

changes in market equilibrium: increases in demand & supply

leads to a higher equilibrium quantity &

nominal price

absolute price of a good, unadjusted for inflation

real price

the dollar price of a good relative to the average dollar price of all other goods

Consumer Price Index (CPI)

measure of the aggregate price level; represents the price level to purchase a basket of goods a typical Canadian would normally buy at a given year; % changes in CPI measure the rate of inflation

calculating real price using CPI

real price \= nominal price x (CPI base year / CPI current year)

calculation of price after inflation rate

*assumes inflation rate doesn't change
price \= original price x (1 + inflation rate %)^difference in years

elasticity

a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants; % change in one variable resulting from a 1% change in another

(midpoint) price elasticity of demand

a measure of how much the quantity demanded of a good responds to a change in the price of that good (at a particular point on the demand curve);
\= % change in quantity demanded / % change in price OR (change in quantity / change in price) x (price / quantity) OR x (average price / average quantity) for midpoint

how can we use the slope of a demand curve to calculate elasticity?

slope \= (change in price / change in quantity) which is the inverse of the first part of the elasticity equation

can elasticity differ along the same demand 'curve' even if it's linear?

yes, it can differ because although the slope (i.e., change in quantity / change in price) stays the same, the specific point coordinates differ

price elasticity of demand is a \___ number b/c ...

negative

if the price elasticity of demand is \> 1 in magnitude, demand is ...

elastic

if the price elasticity of demand is \= 1 in magnitude, demand is ...

unit elastic

if the price elasticity of demand is < 1 in magnitude, demand is ...

inelastic

factors that affect price elasticity of demand

1. \# of substitutes
2. luxury goods & necessity goods
3. price of goods relative to income
4. the time period under consideration

infinite/perfect elasticity

the extremely elastic situation of demand or supply where quantity changes by an infinite amount in response to any change in price; horizontal in appearance

zero elasticity/perfect inelasticity

the highly inelastic case of demand/supply in which a % change in price, no matter how large, results in zero change in the quantity; vertical in appearance

income elasticity of demand

a measure of how much the quantity demanded of a good responds to a change in consumers' income;
\= % percentage change in quantity demanded / % change in income OR (change in quantity / change in income) x (income / quantity)

linear demand function equation

Qd = a - bP (+ fI) (+ gp) \n p = price of good B

cross-price elasticity of demand

the % change in the quantity demanded of one good resulting from a 1% change in the price of another good \n price elasticity of good B = % percentage change in quantity demanded of good A / % change in price of good B OR (change in quantity of A / change in price of B) x (price of B / quantity of A)

If goods are substitutes, cross price elasticity is...

positive

if goods are complements, cross-price elasticity is

negative

price elasticity of supply

a measure of how much the quantity supplied of a good responds to a change in the price of that good
\= % percentage change in quantity supplied / % change in price OR (change in quantity / change in price) x (price / quantity)

arc elasticity of demand

price elasticity calculated over a range of prices
\= % percentage change in quantity demanded / % change in price OR (change in quantity / change in price) x (average price / average quantity)

what does 'b' represent in the demand function Q = a- bP?

'b' represents (change in QUANTITY / change in PRICE); inverse of slope

for non-durable goods, their demand is much more PRICE elastic in the ___ run than in the ___ run

more price elastic in the LONG run \n less elastic in the SHORT run

for durable goods (e.g., fridge, car), their demand is much more PRICE elastic in the \___ run and less elastic in the \___ run

more price elastic in the SHORT run
less elastic in the LONG run

for most products, \___ run supply is much more price elastic than \___ run supply because ...

LONG run supply is much more price elastic than short run supply b/c firms face capacity constraints in the short run and need time to expand capacity by building new production facilities & hiring workers

general form of demand & supply function

demand: Qd = a - bP \n supply Qs = c + dP

market failure

situation in which an unregulated competitive market is inefficient because prices fail to provide proper signals to consumers and producers

deadweight loss

the reduction in total surplus that occurs when the economy produces at an inefficient quantity (i.e., not at equilibrium
(usually the triangular area between the equilibrium and the new quantity)

consumer surplus

the difference between what a consumer is willing to pay for a good or service and the actual price the consumer pays

producer surplus

the difference between the price that the producer actually received and the price the producer would have been willing to accept

social / economic / total surplus

the sum of consumer surplus and producer surplus

the total surplus is largest at ...

the equilibrium quantity & price, demonstrating the economic efficiency of the market equilibrium

is it possible to produce greater consumer surplus without reducing producer surplus at the equilibrium?

no

price ceiling

the maximum price that can be legally charged for a good or service

if a price ceiling is set below the equilibrium ...

a SHORTAGE occurs b/c the market price is not allowed to rise to the equilibrium level, so quantity demanded exceeds quantity supplied
quality is also likely to deteriorate

price floors

legally established minimum prices for goods or services

if a price floor is set above the equilibrium ...

a SURPLUS occurs, b/c quantity supplied exceeds quantity demand

3 steps of consumer behavior

1. budget constraint (limited income)
2. consumer preferences
3. consumer choices (which combination maximizes utility/satisfaction)

how does a change in INCOME affect the budget line?

there will be a parallel shift in the curve left (decrease) or right (increase) but the slope won't change

how does a change in PRICE (of one good) affect the budget line?

budget line/curve will rotate upon the unchanged good's intercept either inward (increase) or outward (decrease)

basic assumptions about consumer preference (3)

* completeness: preferences are assumed to be complete, consumers can compare and rank all possible baskets


* transitivity: if a consumer prefers A to B, and B to C, then the consumer also prefers A to C
* more is better than less: consumers always prefer more of any goods to less

indifference curve

a curve that shows all combinations of goods (market baskets) that provide the consumer with the same satisfaction/utility
i.e., the consumer finds all combinations on a curve equally preferred

marginal utility (MU)

additional satisfaction/utility obtained from consuming one additional unit of a good
\= change in total utility / change in quantity consumed

diminishing marginal utility

decrease in additional satisfaction or usefulness as additional units of a product are acquired
i.e., as more of a good is consumed, the consumption of additional amounts will yield smaller additions to utility

marginal rate of substitution (MRS)

the maximum amount of good X that a consumer is willing to give up in order to obtain one additional unit of good Y

diminishing MRS

As we obtain more of good X relative to good Y, the fewer Y we are willing to give up for more X

we generally assume \___ marginal utility which implies \___ marginal rate of substitution

diminishing

all indifference curves for an individual are ...

parallel

does the amount of total utility change along the indifference curve?

no

what does the slope of an indifference curve tell us?

helps determine consumer's preference

utility is maximized when ...

indifference curve is tangent to the budget constraint line (slopes are equal)

slope of indifference curve

\= MUx / MUy
\= marginal utility of X / marginal utility of Y

slope of budget line

\= Px / Py
\= price of X / price of Y

what does the indifference curve look like for goods that are PERFECT COMPLEMENTS?

a bunch of L-shaped corners (e.g., shoes - utility of one right shoe doesn't change no matter how many left shoes there are)

what does the indifference curve look like for goods that are PERFECT SUBSTITUTES?

multiple parallel linear lines

the maximizing market basket must satisfy two conditions:

a. located on the budget line
b. must give the consumer the most preferred combination of goods & services

conditions of utility maximization

MRS \= Px / Py
MU1 / P1 \= MU2 / P2 (the last dollar spent on each good provides the exact same marginal utility)

foundations of demand curves

1. with a constant price for good Y, the price of X increases so the budget constraint rotates clockwise and the utility

explicit costs

the actual payments a firm makes to its factors of production and other suppliers (e.g., wages, rent)

implicit costs

represent the opportunity cost of using resources that the firm already owns (e.g., working while not earning a formal salary, depreciation)

assuming 2 inputs: \___ & \___, what is the equation for a firm's total expenditure/budget?

labour (L) & capital (K)
\=L x w + K x c (w: wage rate; c: cost of capital, Y: total budget)

given a two-factor model, the budget constraint line of a firm is a ___ sloping ___ line

downward sloping linear line

perfectly competitive market (4)

1) many buyers and sellers
2) all firms selling identical products
3) no barriers to enter/leave the market
4) both the buyers and the sellers are price takers (the price is determined by the market demand and supply together)

assume that the labour market is \___ competitive, so \___ are the price takers in the labour market

perfectly, firms

marginal expenses of labor

the change in total labour costs from employing one extra worker
w0, i.e., where the labour supply curve to firms is horizontal

marginal expenses of capital

the expense of renting a unit of capital for one time period

types of costs (5)

* average costs


* marginal costs
* total costs
* fixed costs (costs of fixed inputs)
* variable costs (costs of variable inputs)-

2 ways of measuring per unit costs

* average costs: cost on average of producing a given quantity — total cost divided by the quantity of output produced (AC = TC / Q)
* marginal costs: cost of producing one more unit of output — change in total cost divided by the change in output/quantity

average total cost (ATC) formula

total cost ÷ quantity of output

identify & explain the shape of an average total cost (ATC) curve

typically U

average variable cost (AVC) formula

variable cost ÷ quantity of output

position of average variable cost (AVC) curve

will always lie below the curve for ATC at any level of output
as output grows, fixed costs become relatively less important (since they do not rise with output), so average variable cost sneaks closer to average cost

explain the relationship between marginal cost (MC) and average total cost (ATC)

* if MC is BELOW ATC (left of intersection), producing one additional unit will REDUCE average costs overall & ATC curve will be downward-sloping in this zone
* if MC is ABOVE ATC (right of intersection), producing one additional unit will INCREASE average costs overall & ATC curve will be upward-sloping in this zone

\

an _RAC curve is based on a group of _RAC curves, each of which represents ...

an LRAC curve is based on a group of SRAC curves, each of which represents one specific level of fixed costs

long-run average cost (LRAC) curve

shows the lowest cost at which a firm is able to produce a given quantity of output in the long run when no inputs are fixed \n i.e., shows the cost of producing each quantity in the long run, when the firm can choose its level of fixed costs and thus, choose which short-run average costs it desires