Determinants of Price Elasticity of Demand
Availability of substitutes, Luxury or Necessity, The share of total budget, time dimension
Availability of substitutes
greater the number of substitutes, the more ELASTIC the demand, when all firms in a market produce products which are perfect substitutes for each other, the demand is perfectly elastic
Luxury or Necessity
A product is a luxury will have more elastic demand than a product deemed necessity. Luxury is a product that consumers can easily do without compared to necessity
The share of the total budget
the larger the proportion of a budget the good constitutes, the more elastic the demand
Time dimension
the more time the consumer is given to adjust to the price change, the more elastic the demand
Total Revenue=
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Relationship between price elasticity and total revenue
both calculations use price and quantity, they are directly proportional. All varies on price.
Total Revenue decreases...
-Elastic (Ed>1) and Price increases
-Inelastic (Ed<1) and Price decreases
Total Revenue increases...
-Elastic (Ed>1) and Price decreases
-Inelastic (Ed<1) and Price increases
No change in total revenue...
-Unit Elastic (Ed=1)
Utility
the satisfaction associated with the consumption of goods and services
Marginal utility
the change in total utility divided by the change in quantity consumed
Marginal Cost (MC)=
0
Marginal Benefit (MB)
The additional benefit created when an action is taken; a measure of the value of each additional unit to the consumer in terms of how much money each addition unit is worth to the consumer, or the maximum amount the consumer would pay for each additional
Law of diminishing marginal utility
The observation that as consumption of one good increases relative to other goods, the additional satisfaction gained form consuming yet another unit of that good eventually declines
Law of diminishing marginal returns
Economic theory of production suggesting that marginal cost increases as output increases in the short run
Efficiency
The outcome of voluntary exchange in free markets, assuming no market failures, and consistent with the best use of scarce resources (MB=MC)
Deadweight Loss
The reduction in total surplus that occurs when output is not at the intersection of competitive market supply and demand curves the difference between the maximum total consumer and producer surplus and the total consumer and producer surplus that result
Consumer Surplus
the maximum amount the consumer is willing to pay for a product minus the amount the consumer actually has to pay (the market price). Top triangle that is below MB and above equilibrium price, (CS=1/2 B*H)
Marginal Benefit (MB)
the additional benefit gained from consuming one more unit of a good or service (it is reflected in the demand curves and has a downward slope)
Producer Surplus (PS)
The actual amount a producer receives for a product (the market price minus the minimum amount the producer is willing to accept in exchange for the product (marginal cost). Bottom triangle that is below equilibrium price and above MC
Inefficiency
occurs when MB does not equal MC and it happens when there are price ceilings/floors, taxes, tariffs, quota, monopoly, public goods, or externalities
Ad velorem tax
a tax levied on a product as a percentage of the product's price
Exhaustible resources
natural resources that can be used only once and cannot be replaced once they are used, such as coal and oil
Price ceilings
a maximum legal price set by the government; good for buyer (low prices) but causes shortages
Price floor
a minimum legal price set by the government; good for sellers (high prices) but causes surpluses
Progressive
an income tax with an increasing average tax rate
Proportional
an income tax with a constant average tax rate
Regressive
an income tax with a decreasing average tax rate
Shortage
Occurs when the quantity demanded exceeds the quantity supplied (D>S); is measured by subtracting the quantity supplied from the quantity demanded.
Statutory tax incidence (burden)
Indicates which party, buyers, or sellers, is legally responsible for the payment of a tax
Surplus
Occurs when the quantity supplied exceeds the quantity demanded; the size of this is measured by subtracting the quantity demanded from the quantity supplied
Tax revenue=
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Deadweight Loss (DL)=
0
Total Surplus (TS)=
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Perfectly Elastic Demand Curve and Taxes
Seller bares the burden of the taxes
Perfectly inelastic Demand Curve and Taxes
Buyer bares the burden of the taxes
Coase Theorem
states that an efficient outcome can be achieved without any need for active government involvement as long as property rights are clearly defined and transaction costs are sufficiently low
Common resources
Goods that are rival and nonexclusive; examples include wild animals and clean air
Free-rider problem
the problem that occurs when individuals are able to enjoy the benefits of a public good without paying
Marginal social benefit (MSB)
The marginal benefit to society, including both private and spillover benefits
Marginal social cost (MSC)
the marginal cost to society, including both private and spillover costs
Market Failure
An obstacle to efficiency; examples include externalities, public goods, common resources, imperfect information, and imperfectly competitive markets
Monopoly
an industry that is controlled by a single firm
negative externalilty
a cost that is borne by a third party or a spillover cost; an example is environmental costs associated with pollution
nonexcludable
a characteristic of a public good; if it is impossible to keep non-payers from receiving the benefits of the good once it has been provided
nonrival
a characteristic of a public good; if the use of that good by one consumer does not preclude the use of it by another consumer
Positive externalilty
a benefit that is enjoyed by a third party or a spillover benefit;an examples is the benefit to society of an educated population or vaccines
public good
a good that is nonrival and nonexcludable
tragedy of the commons
the tendency for common resources to be used more than is desirable from society's point of view
accounting profit
total revenue minus total explicit costs
average product (AP)
the measurement of how many units of output, on average, are produced by each unit of input. For labor it gives output per worker and calculated as Q/L
Barriers to entry
obstacles that make it unprofitable or impossible for new firms to enter an industry or market
Corporation
a legal entity separate from its owners; the liability of each owner (stockholder) is limited to the value of the initial investment
economics cost
all costs of production, both implicit and explicit
Economic loss
negative economic profit, occurs when total revenue is less than total economic costs
Economic profit
total revenue minus toal economic costs (both implicit and explicit)
Explicit costs
costs that require direct monetary payments to the factors of production
Firm
an organization that transforms inputs into outputs for the purpose of sale; assumed objective is profit maximization
Fixed inputs
the factors of production that are held constant in the short run
implicit costs
the opportunity costs to the firm for the factors of production for which it does not make a direct monetary payment
Long run
a period of time in which all factors of production are variable
Marginal product (MP)
the change in output divided by the change in the variable input
Monopolistic competition
an imperfectly competitive market structure; characterized by many buyers and sellers, differentiated products, no barriers to entry, and perfect information
Normal profit
zero economic profit; occurs when total revenue is equal to all costs of production, including opportunity costs. Is considered to be a cost of staying in business
Oligopoly
an imperfectly competitive market structure characterized by a few dominant firms, interdependent decision-making, and strategic behavior, In most cases, barriers to entry exist and the product may be either identical or differentiated
Partnership
a firm with two or more owners with unlimited liability
Production
the relationship between inputs and output
Profit
total revenue minus total costs
Short run
a period of time in which one or more factors of production are held constant
Total Revenue
the price of the good being sold multiplied by the number of units sold; price time quantity or PQ
Variable inputs
the factors of production that can be changed in the short run
Zero economic profit
Means owners are receiving a return equal to what they would earn in their next-best alternative opportunity
Average fixed cost (AFC)=
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Average total cost (ATC)=
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Average variable cost (AVC)=
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Constant returns to scale
occur when a firm increases its inputs by some percentage, and output increases by the same percentage; in this case, average costs remain constant as production (output) increases
Diseconomies of scale
occur when a firm increases inputs by some percentage, and output increase by a smaller percentage; in this case, average costs rise as production (output) increases
Economies of scale
occur when a firm increases inputs by some percentage, and output increase by an even larger percentage; in this case, average costs fall as production (output) increases
Minimum efficient scaled
the smallest level of production corresponding to constant returns to scale
Total Cost (TC)=
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Total Fixed Cost (TFC)
costs that do not change when output changes and must be paid even if the firm does not produce output; example is rent
Total Variable cost (TVC)
costs that change when output changes and are incurred only if the firm produces output
Marginal Revenue (MR)=
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Perfect Competition
a market structure characterized by many buyers and sellers, identical products, no barriers to entry, and perfect information
Price-taker
a firm that is too small to influence the market price
Profit-maximizing rule
producing up to the point where MR=MC
Shutdown point
a firm will stop production to minimize losses if price falls below the minimum AVC because the loss will be greater than TFC if it produces in the short run
P>AVC => Continue to operate
P<AVC => shut down
Total Approach
?= TR-TC
where ? is economic profit