Econ 102 Exam #2 PSU

relatively flat graph indicates

steep one indicates

small change in price will cause a huge change in quantity demanded

even with a very large price increase, Qd will only fall a small amount

elasticity

the sensitivity between 2 variables

price elasticity of demand

the sensitivity of the change in the qd of a good in response to a change in the price of the good

demand is elastic when...

the qd is relatively responsive to a change in the products own price

demand is inelastic when...

the qd is relatively unresponsive to changes in price

elastic goods?

goods with many substitutes, specific brand of cereal

inelastic goods

gas, college tuition, no good substitutes, cigs, toilet paper, life saving drugs

determinants of price elasticity of demand:

1. the number and quality of substitutes

2. share of income spent of a good directly relates to price elasticity of demand

3. passage of time

more substitutes implies

elastic demand

what does share of income mean? how does it effect price elasticity?

how much of my wallet do I have to give up?

cars, houses --> elastic

gum, candy --> inelastic (if price change, not a big deal will still buy)

2nd Law of Demand

demand is more responsive to price in the long run than in the short run.

passage of time:

long run = more ___

short run = more ____

elastic

inelastic

Formula for demand elasticity

Ed = %change Qd / %change P < 0

demand elasticity will always be (neg/pos) due to

neg; the downward sloping nature of the demand curve

if price increases, qd will...

decrease

(vice versa)

how to measure percent changes?

new - old / old

from the equation, when do you know it is elastic demand?

Ed < -1

big/small = Qd sensitive

from the equation, when do you know it is inelastic demand?

-1

from the equation, when do you know it is unit elastic?

Ed=1

a given % change in p results in the same % change in Qd

for a linear demand function...

slope is constant, but Ed changes

T/F

slope and elasticity are the same thing

False

slope is only related to elasticity

Point elasticity: pro?

calculate elasticity at any point, without need to compare percent changes

point elasticity formula:

Ed = change in Q / change in P x P/Q

or

1/slope x P/Q

point elasticity formula with derivative:

Ed =(coeff on price) x P/Q

pg 97

On a graph where is elastic, unit price, and inelastic?

elastic is on the upper portion

unit elastic is the midpoint

inelastic is the lower portion under midpoint

pg98

total revenue is

TR = P x Q

where is TR maximized?

at midpoint Ep=-1

pg 101 !!

if price elasticity of demand is elastic... revenue can be increased by

selling more units at a lower price

if price elasticity of demand is inelastic... revenue can be increased by

selling fewer units at a higher price

if price elasticity of demand is unit elastic... revenue can be increased by

CANT! revenue already at max

what is perfectly elastic mean? what does the graph look like?

you will only buy this good at one price, any increase in price means you will buy none of this good

example: $10 bill

horizontal; slope = 0

what is perfectly inelastic mean? what does the graph look like?

no matter what happens to price, you will always buy the same amount of good

example: life saving drugs, surgery

vertical slope

what does a special shaped non-linear demand curve mean? what does the graph look like?

elasticity is -1 at all points on the curve

no matter what price spend same amount of money on same good

formula for supply elasticity

Es = %change in quantity supplied / %change in price > 0

why is supply elasticity greater than zero?

because the supply curve is positively sloped

Determinants of supply elasticity:

1. how costly is it to produce more output units when more inputs are needed

2. time

supply elasticity: how costly is it to produce more output units when more inputs are needed?

low increase in costs to increase production = elastic supply

high increase in costs to increase production = inelastic supply

supply elasticity: time?

supply is more elastic in the long run, and more inelastic in the short run

(long run = more tech advances)

income elasticity of demand

what will this do to the graph?

the relative change in the quantity demanded of a good in response to a change in income

measure how far the demand curve horizontally shifts when income changes

income elasticity of demand formula:

Ei = %change of Qd / %change in income

(at a given price)

normal good v. inferior good

income increase = buy more normal good and buy less inferior goods

for a normal good, income elasticity of demand is ____, for an inferior good, income elasticity is _____

positive

negative

luxury vs. necessity

income elasticity

luxury -- Ei > 1

necessity -- 0 < Ei < 1

what does it mean when income elasticity of demand is zero?

example

consumption unchanged as income changes

example: insulin

cross price elasticity of demand

the relative change in the quantity demanded of a good in response to change in price of another good

(horizontal shift in demand)

cross-price elasticity of demand formula:

Exy = %change of Qd ^ x / %change of P^x

(@ a given price of x)

if the 2 goods are substitutes, the cross-price elasticity will be

positive

if the 2 goods are complements, cross-price elasticity will be

negative

if the 2 goods are unrelated, the cross-price elasticity will be

zero

utility is

the satisfaction from consuming a good or service

total utility

total satisfaction resulting from the consumption

marginal utility

the additional satisfaction obtained by consuming one more unit of a good

marginal utility is...

diminishing

it decreases as we consume more and more of a good

as we consume more, each additional unit of the good will probably still increase happiness, but it will not increase as much as the previous unit

pg 116

total utility v marginal utility on a graph

total utility... how much each one gives you

marginal utility... the difference between the 1st 2nd, 3rd 4th, etc.

can marginal utility ever be negative? total utility?

examples:

yes

consuming to much food or alcohol

really overdoing it

util

unit of happiness

cardinal utility

placing numerical values on utility

ordinal utility

ranking between choices

formula for comparing different utilities:

MUx/ Px = MUy/Py

5 assumptions about MU:

1. consumer spends all income

2. 2-good model

3. 2 goods inherently substitutes

4. change in consumption of x cause change in MUx

5. change in consumption of x does not cause change in Px

exogenous

occurring from the outside

economic rent

a payment for the use of any resource over and above its opportunity cost

(how much more a resource is worth in its highest valued used compared to its next best use)

economic rent associated with

david ricardo

what types of people would receive the largest economic rent on their labor?

professional sports superstars

music, movie stars

successful innovators

what rent does:

makes sure that resources are allocated to their highest valued use

when rent on labor may be larger:

competition is lower

resources cant be replicated

tend to be "tournament" or "winner takes all"

a firm uses the factors of production in order to

produce a good or service to be sold at a profit

firm

a business organization that employs resources to produce goods or services for profit

owns at least one plant or facility

formula for total revenue

TR = P x Q

Accounting profit formula

Accounting Profit = TR - total explicit costs

explicit costs

examples

costs that managers must take account of because they must be paid

wages, taxes, raw materials, insurance

implicit costs

expenses that managers do not have to pay out of pocket and hence do not normally explicitly calculate

no direct payment

opportunity cost of capital is the...

returns you give up by NOT investing elsewhere

Accounting profits vs economic profits

econ profits include opportunity costs

formula for economic profits

accounting profit - implicit costs

normal rate of return

the costs of continuing to run your business instead of doing something else

the goal of the firm

profit maximization

production

any activity that results in the conversion of resources into products that can be used in consumption

(using inputs to make goods and services)

production function

given a quantity of inputs. how much output can we make?

labor

L

capital

K

production function formula

Q = f(K,L)

output (Q) is a function of inputs

in the short run for production what cannot be changed?

capital

plant size

the physical size or number of factories that a firm owns and operates to produce its output

in the long run for production what can be changed?

all factors of production can be varied

total product

TP: total amount of output produced by a firm for some time period

Average product

AP: total product divided by the number of units of the variable factor used in production

APL

average product of labor

APK

average product of capital

how to find APL?

APL = TP/L (total # of workers)

how to find APK?

APK: TP/K (total # of capital units)

marginal product

the physical output that is due to the addition of one more unit of a variable factor of production

MPL

marginal production of labor

MPK

marginal production of capital

how to find MPL?

MPL = (change in TP)/(change in labor)

how to find MPK?

MPK = (change in TP)/(change in capital)

law of diminishing marginal product

after some point, successive increases in a variable factor of production added to fixed factors of production with result in smaller increases in output

when MP is above AP, then

when MP is below AP, then

AP is rising

AP is falling

fixed cost

examples

FC: costs that do not vary with output (Q)

rent, insurance

total fixed cost

TFC