Micro Economics Exam 2

Unit 6 - Elasticity

Elasticity: A measure of how responsive one variable is to a change in another variable; calculated as the percentage change in quantity divided by the percentage change in price

Types of Elasticity

• Price Elasticity of Demand

MIDPOINT FORMULA

• % change in Quantity Demanded = ( (Q2-Q1)/((Q2+Q1)/2) ) * 100

• % change in Price = ( (P2-P1)/ ((P2+P1)/2) ) * 100

A measure of how responsive QUANTITY DEMANDED is to a change in price

• When an increase in price leads to a large decrease in quantity demanded, the good is ELASTIC

• When an increase in price leads to a small decrease in quantity demanded, the good is INELASTIC

Example →

Cost Price Elasticity: A measure of the effect of a change in the price of one product on the quantity demanded of another; calculated as the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good. 

𝐸𝐶 =𝑃𝑒𝑟𝑐𝑒𝑛𝑡 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑓𝑜𝑟 𝐺𝑜𝑜𝑑 1 / 𝑃𝑒𝑟𝑐𝑒𝑛𝑡 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒 𝑓𝑜𝑟 𝐺𝑜𝑜𝑑 2

Cross-Price Elasticity of Demand Types 

• Substitutes: Goods, services, or resources that are viewed as replacements for one another.

• Complements: Goods, services, or resources that are used or consumed with one another.

Income Elasticity of Demand:  A measure of how responsive demand is to a change in consumer income

𝐸𝐼 = 𝑃𝑒𝑟𝑐𝑒𝑛𝑡 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 / P𝑒𝑟𝑐𝑒𝑛𝑡 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐼𝑛𝑐𝑜𝑚e

Income Elasticity of Demand Types 

Normal: Goods, services, or resources that are consumed more when income increases 

Inferior: Goods, services, or resources that are used or consumed less when income increases

Because an inverse relationship exists between the price and the quantity demanded, price elasticity is a NEGATIVE

Unit 7 - Market Failures

Market Failures: A situation in which a market fails to produce the efficient level of output that maximizes total surplus

• Private Market: A market in which the demand and supply curves represent the benefits and costs to only the consumers and producers in the market.

• Social (External) Market: A market in which the demand and supply curves represent the benefits and costs to everyone

Externality → The benefit enjoyed by or cost imposed on a third party not directly involved in the production or consumption of a good or service.

TYPES OF EXTERNALITIES

POSITIVE: The unpaid benefit enjoyed by a third party not directly involved in the production or consumption of a good or service.

NEGATIVE: The uncompensated cost imposed on a third party not directly involved in the production or consumption of a good or service.

When externalities exist, outside intervention may be able to improve the market outcome, increasing efficiency and economic surplus.

GOODS

• Nonrival: The characteristic of some goods or services whereby the consumption of the good or service by one person does not diminish the amount available to someone else. Sometimes referred to as nonrival in consumption.

• Rival: The characteristic of some goods or services whereby the consumption of the good or service by one person DOES diminish the amount available to someone else. Sometimes referred to as a rival in consumption.

• Nonexcludable: A characteristic of some goods or services whereby people cannot easily be prevented from consuming the good or service, even if they don’t pay for it. Sometimes referred to as nonexcludable in consumption. (Think PUBLIC facilities)

• Excludable: A characteristic of some goods or services whereby people CAN easily be prevented from consuming the good or service. Sometimes referred to as excludable in consumption. (Think PRIVATE → Golf Club Membership)

Types and Examples of Goods 

1) Public 

2) Private 

3) Common Resource

4) Club

Tragedy of the Commons: An economic concept that describes a situation in which individual users, acting in their own self-interest, overuse and deplete a shared resource, leading to the overall detriment of the whole group.

The Free-Rider Problem: A ‘free rider’ is an agent that benefits from something without expending any effort or paying for it. In other words, an individual who uses a good or service without paying for it.

Property Rights: The exclusive right to determine how a resource is used.

Coase Theorem: If a property right is well defined and transaction costs are low, resources will naturally gravitate to their highest valued use, regardless of who owns the property right. 

Transaction Costs: Involve(s) the costs in terms of time energy and resources associated with searching out negotiating and completing a transaction.

Unit 8 - Consumer Choice

Utility: The satisfaction or happiness received from the consumption of goods and services

• Measured in Utilis

Total v.s. Marginal Utility

 Total Utility: The total satisfaction or happiness received from the consumption of a good, service, or combination of goods and services

Marginal Utility: The additional satisfaction or happiness received from the consumption of an additional unit of a good or service

Law of Diminishing Marginal Utility: A principle in economics that states that the marginal utility associated with consumption of a good or service becomes smaller with each extra unit that is consumed in a given time period

EXAMPLE: Suppose eating one hamburger gives you a total utility of 20 utils. If you were to eat a second hamburger directly after, you’re total utility would now equal 30 utilis. This is because you are not receiving the same amount of utils (or the same amount of satisfaction) from eating a second burger. This describes marginal utility, which is the additional satisfaction you receive from consuming an additional good. The more burgers you consume, the marginal utility becomes smaller and smaller because you are receiving LESS satisfaction from each burger. This is the law of diminishing marginal utility.

Equal Marginal Principle: The idea that consumers maximize their utility when they allocate their limited incomes so that the marginal utility per dollar spent on each of their final choices in a bundle is equal. 

Budget Line: A line showing the different combinations of two products that can be purchased with a given budget and at a known set of prices

Indifference Curves: A curve that shows the combinations of two products that generate the same amount of total utility or satisfaction.

Consumption Bundle: Total amount of goods and services that an individual consumes

**The utility maximizing bundle of goods and services occurs where the indifference curve is tangent to the budget line.

Unit 9 - Production

Total Product: The total amount of output produced with a given amount of resources.

Marginal Product: The additional production received from using one additional unit of a resource.

Average Product: The average production received from each unit of resource.

Example: Sandwich Shop

Marginal Returns

• Increasing: A characteristic of production whereby the marginal product of the next unit of a variable resource utilized is greater than that of the previous variable resource.

• Decreasing: A characteristic of production whereby the marginal product of the next unit of a variable resource utilized is less than that of the previous variable resource

Types of Costs

• Explicit: Monetary payments made by individuals, firms, and governments for the use of land, labor, capital, and entrepreneurial ability owned by others. Also known as accounting costs.

• Implicit: The opportunity costs of using owned resources; costs for which no monetary payment is explicitly made.

Opportunity Cost: The value of the next-best foregone alternative.

Economic Costs = Implicit Costs + Explicit Costs

Fixed, Variable, and Total Costs

• Fixed: Costs that DO NOT CHANGE with the amount of output produced

• Variable: Costs that change with the amount of output produced, increasing as production increases and decreasing as production decreases

Variable costs = Total cost - total fixed cost

Total Costs

AVERAGE COSTS

Marginal Cost: The additional cost associated with one more unit of activity.

OR

The short run is a period of time in which atleast one input of production is fixed

Long-run Average Total Cost Curve: A curve showing the lowest average total cost possible for any given level of output when all inputs of production are variable

Returns to Scale

• Economies of Scale: A condition in which the long-run average total cost of production decreases as production increases.

• Constant Returns to Scale: A condition in which the long-run average total cost of production remains constant as production increases.

• Diseconomies of Scale: A condition in which the long-run average total cost of production increases as production increases

Economic Profit: Revenue - Implicit & Explicit Costs

Therefore, economic COSTS = Implicit & Explicit Costs

Accounting Profit: Revenue -  Explicit Costs

Business operating decisions should be based on ECONOMIC profit.