CA5102: Managerial Economics Quiz 2

Elasticity

A measure of the responsiveness of one variable to changes in another variable.

%ΔG / %ΔS

Elasticity Formula

Elastic Demand

A price increase (decrease) leads to a decrease (increase) in total revenue.

TRUE

TRUE OR FALSE: Demand is elastic if the absolute value of the own price elasticity is greater than 1.

Inelastic Demand

A price increase (decrease) leads to an increase (decrease) in total revenue.

FALSE

TRUE OR FALSE: Demand is inelastic if the absolute value of the own price elasticity is greater than 1.

Unitary Elastic Demand

Total revenue is maximized.

Perfectly Elastic Demand

The own price elasticity of demand is infinite in absolute value.

Perfectly Inelastic Demand

The own price elasticity of demand is zero.

Factors Affecting the Own Price Elasticity of Demand

Availability of Consumption Substitutes, Time/Duration of Purchase Horizon, Expenditure Share of Consumers' Budgets.

Marginal Revenue

Measures the additional revenue due to a change in output.

P( 1+E / E )

Marginal Revenue Formula

Own Price Elasticity

Measures the responsiveness of a percentage change in the quantity demanded of good X to a percentage change in its price.

Cross-Price Elasticity

Measures the responsiveness of a percent change in demand for good X due to a percent change in the price of good Y.

Income Elasticity

Measures the responsiveness of a percent change in demand for good X due to a percent change in income.

High Income Elasticity

Most affected by a recession.

Low or Negative Income Elasticity

Not affected that much by a recession.

Own Advertising Elasticity

The ratio of the percentage change in the consumption of X to the percentage change in advertising spent on X.

Cross-Advertising Elasticity

Measure the percentage change in the consumption of X that results from a 1 percent change in advertising toward Y.

Qx^d = α0 + αxPx + αyPy + αmM + αhPh

Linear Demand Function

αx( Px / Qxd )

Own Price Elasticity (Linear)

αy( Py / Qxd )

Cross-Price Elasticity (Linear)

αm( M / Qxd )

Income Elasticity (Linear)

ln Qxd = β0 + βX ln PX + βY ln PY + βM ln M + βH ln H

Non-Linear Demand Function

βX

Own Price Elasticity (Non-Linear)

βY

Cross Price Elasticity (Non-Linear)

βM

Income Elasticity (Non-Linear)

Y = α + bX + e

True (Population) Regression Model

Y = â + b̂ X

Least Squares Regression Line

Least Squares Regression

The line that minimizes the sum of squared deviations between the line and the actual data points.

Standard Error

Measures how much each estimated estimate varies in regressions based on the same true demand model using different data.

T-Statistic

The ratio of the value of a parameter estimate to the standard error of the parameter estimate.

R-Square

Fraction of the total variation in the dependent variable that is explained by the regression.

Adjusted R-Square

A version of the R-square that penalizes researchers for having few degrees of freedom.

F-Statistic

A measure of the total variation explained by the regression relative to the total unexplained variation.

P-Value

Shows a more precise measure of significance.

Models of Individual Behavior

Help us understand how consumers will respond to the choices that confront them.

Consumer

An individual who purchases goods and services from firms for the purpose of consumption.

Consumer Opportunities

A set of possible goods and services consumers can afford to consume.

Consumer Preferences

Determine which set of goods and services will be consumed.

Completeness

The consumer is capable of expressing a preference for, or indifference among, all bundles.

Indifference Curve

The combinations of goods X and Y that give the consumer the same level of satisfaction.

Marginal Rate of Substitution

The rate at which a consumer is willing to substitute one good for the other and still maintain the same level of satisfaction.

Diminishing Marginal Rate of Substitution

As a consumer obtains more of good X, the amount of good Y he is willing to give up to obtain another unit of good X decreases.

Transitivity

The assumption of transitive preferences, together with the more-is-better assumption, implies that indifference curves do not intersect one another.

The Budget Constraint

A restriction set by prices and income that limits bundles of goods affordable to consumers.

Budget Set

The combinations of goods that are affordable for the consumer.

Budget Line

The combinations of goods that exhaust the consumer's income.

The Market Rate of Substitution

The rate at which one good may be traded for another in the market.

Consumer Equilibrium

The consumption bundle that is affordable and yields the greatest satisfaction to the consumer.

Substitutes

An increase (decrease) in the price of X leads to an increase (decrease) in the consumption of Y.

Complements

An increase (decrease) in the price of X leads to a decrease (increase) in the consumption of Y.

Normal Good

An increase (decrease) in income leads to an increase (decrease) in the consumption of X.

Inferior Good

An increase (decrease) in income leads to a decrease (increase) in the consumption of X.

Substitution Effect

The movement along a given indifference curve that results from a change in the relative prices of goods, holding real income constant.

Income Effect

The movement from one indifference curve to another that results from the change in real income caused by a price change.

Market Demand

The horizontal summation of individuals' demands.