Midterm 2 - AUSTIN BOYLE - ECON 102

Price elasticity of demand (Ed)

how responsive the change in quantity demanded of a good is to a change in the price of a good.

Equation for Elasticity of Demand

%Change in Quantity Demanded / % Change in Price

Equation for Price Elasticity

(Qd2-Qd1)/(Qd1+Qd2)/2 divided by

P2 - P1 / P1+P2 / 2

Interpretation of being perfectly elastic

Price is everything (Any increase price change will cause quantity demanded to fall to zero)

Interpretation of being relatively elastic

Price is more important than quantity you purchase (1% change in prices causes greater than 1% change in quantity demanded)

Interpretation of Unitary

Price and quantity are equally important. (1% change in price causes exactly a 1% change in quantity demanded)

Interpretation of Relatively Inelastic

Price is less important than the quantity you purchase (1% change in price causes less than a 1% change in quantity demanded.)

Interpretation of Perfectly inelastic

Price does not matter (No matter what the price the quantity demanded will be the same)

Make sure to remember that elasticity is not the same as slope

Elasticity NOT Slope (just a note, not a notecard)

3 Factors that affect price elasticity of demand:

1. Availability of substitutes

2. Percent of a consumer's budget spent on buying the good

3. Length of time the market has to adjust to the price change

Availability of substitutes (if there's a lot):

the price elasticity of demand will be elastic. If there is a perfect substitute for a good, elasticity of demand will be perfectly elastic (infinite)

Availability of substitutes (if there are none)

The price elasticity will be inelastic

If a good is a small portion of your budget:

the price elasticity of demand will be inelastic --> the small price difference isn't that much of your budget

If a good is a large portion of your budget:

the price elasticity of demand will be elastic --> it is sensitive because it is a large portion of your budget

Immediate run

no time to adjust, very inelastic (when your gas is on empty)

Short run

there is only a limited time to adjust (more gas stations, more sensitive to cost)

Long run

the amount of time it takes for consumers to fully react to a change in price (change whole scenario and buy a hybrid)

Equation for total revenue:

Price x Quantity

Supply Elasticity

how responsive the quantity supplied of a good is to a change in the good's price

Elasticity of Once in a Lifetime experiences

Have an inelastic demand because they are never going to happen again and you wont care how much money it is

Equation of Supply Elasticity

Percent of Change in Quantity Supplied / % Change in Price

Perfectly elastic supply -

any reduction in price will cause the quantity supplied (person is not willing to sell a product for any less than a certain price) Ex: rare card

Perfectly inelastic supply-

the same quantity will be supplied no matter what the price is. Ex: always 106k seat at Beaver Stadium.

Determinate of supply elasticity:

Ease of finding new inputs, Mobility of inputs, Ability to produce substitute inputs, and time

Ease of finding inputs

the easier it is to find new inputs, the more elastic supply will be

Mobility of inputs

the easier it is to move resources to new locations, the more elastic supply will be.

Ability to produce substitute inputs

as more substitutes become available, supply becomes more elastics.

Time

supply is more elastic in the long run than in the short run

Income elasticity of demand

how much the demand for a good responds to changes in income, while holding the price of a good constant.

Normal goods

as income increases demand will increase resulting in a direct relationship (income elasticity of demand will be positive)

Inferior goods

as income increases demand will decrease resulting in an inverse relationship. (more money, less inferior goods)

Cross elasticity of demand

the percent change of demand for one good divided by the percent change in the price for another good

Equation for cross-elasticity of demand

Percent change in Quantity demanded for good X divided by the percent change in price for good Y

Substitutes (cross-elasticity)

will be positive

Complements (cross-elasticity)

will be negative

Unrelated good (cross-elasticity)

will be zero

Utility

the ability of a good or service to satisfy a want (depends on individual taste and preference)

Util

unit that we use to measure utility

Total utility

utility from consuming all units of a good

Marginal utility

the change in utility when we consume one more unit of a good or service

Equation for Marginal Utility

Change in total utility divided the change in number of units consumed

Marginal

unit that we use to measure utility

Marginal Principle

you should continue an activity as long as the marginal benefit is greater than the marginal cost

Marginal Benefit

the extra benefit from an extra unit of the activity

Marginal Cost

the extra cost associated with an extra unit of activity

IF A GOOD IS FREE, WE WILL CONSUME IT UNTIL THE MARGINAL UTILITY IS ZERO

...

Diminishing marginal utility

the idea that as we consume more of the same good, the extra benefit of each additional unit we consume goes down. (gets old, get sick of it)

Consumer optimum

the combination of goods and services that maximizes a consumer's utility while being faced with a limited income

Opportunity Cost

an individual will increase their rate of consumption as long as marginal utility exceeds opportunity cost

Factors that affect the amount of each good consumed:

1. Price of the goods

2. Income of the consumer

3. Marginal utility received from each good

Substitution effect

when the price of a good or good changes, consumers will substitute cheaper goods in exchange for more expensive goods (ALWAYS IMPORTANT)

Principle of substitution

consumers and producers shift away from goods that become relatively higher in price in exchange for goods that are relatively lower in price

Real-Income effect

if the price of one of the goods you regularly purchase goes down but your income stays the same, your ability to purchase increases (important if the purchase is large % of income)

Factors that cause the negative downward sloping relationship between quantity and price

Diminishing marginal utility, substitution effect, and real-income effect.

Private cost (internal costs)

Costs that are exclusively absorbed by the individuals that incur them

Social costs (external costs)

the full cost absorbed by society when resources are used. (full cost of our actions)

Activities that create social costs:

Driving- Congestion and smog

Airports- Noise pollution

Strip mining- damage to the neighboring environment

Externality

When a private cost (or benefit) moves away from the social cost or benefit

Market failure

When an unrestricted market economy leads to too few or too many resources going to specific economic activity.

Negative externality

when an individuals' actions make a third party worse off. When there are external costs the market over allocates resources to the production of that good.

Positive externality

When an individual's action make a third party better off

Subsides

When the government for pays all or part of goods and services that create positive externalities, which causes demand for the good to shift outward to the right.

Regulation

When the government requires people to consume a good or service. This also causes the demand for the good to shift outward to the right.

Inframarginal externality

An externality where the cost or benefit to the third party is so low that it is not rational to take action to try to reduce or increase the externality.

Public goods

must have the following two characteristics: (1) it is non-rival in consumption, and (2) it is non-excludable.

Non-rivalrous

Everyone can enjoy the good at the same time without detracting from someone else's enjoyment

Non-excludable

Means that you do not have to pay anything to enjoy the good.

Free-rider problem-

when some individuals take advantages of the fact that others will take on the burden of paying for public goods.

Common property

property that is owned by everyone and consequently protected by no one

Tragedy of the common

When property is owned jointly, the incentives to maintain the property starts to disappear because someone else will do it.

Economic rent

paying for the use of any resource above its opp. cost

Sole proprietorship

single owner of a business

Partnerships

owned by two or more people

KNOW FACTORS OF PRODUCTION

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Accounting profit

total revenue - explicit cost

economic profit

total revenue - explicit costs - implicit costs

optimal quantity of air pollution

where the marginal benefit of one additional unit of pollution abatement (reduction) equals the marginal cost of that additional unit