Econ 102 1st Edition Exam 2 Study Guide Market Efficiency Consumer and Producer Surplus Consumer Surplus Maximum willingness to pay price Consumer Surplus savings Measure of a buyers wellbeing from participating in the market The more consumers in the market the higher the surplus o Total consumer surplus sum of individual surpluses Can be displayed graphically on a linear demand curve Calculating area between demand curve and price can give you the consumer surplus Higher price reduces surplus and vice versa Producer Surplus These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute Can be calculated by price minimum willingness to sell o Measures a sellers wellbeing for participating in the market Can be displayed graphically with a linear supply curve Can be calculated by finding the area between the price and supply curve Higher prices raise producer surplus and vice versa Total Surplus and Efficiency of Markets Consumer surplus seller surplus total surplus o Adding buyers does not necessarily increase total surplus o Free markets automatically maximizes total surplus Price Ceilings and Price Floors Scenarios situations where government intervention in markets prevents them from being free prevents prices from moving towards equilibrium o Price Ceilings Set a maximum price for a good or service Goal isto make said goods services more accessible to low income residents In reality it creates a SHORTAGE Lower prices discourage sellers from selling in these markets Binding Price Ceilings Must be set BELOW the equilibrium price o Price Floors Sets a minimum price for a good or service Promotes higher income for suppliers More expensive goods discourage buyers and often causes a SURPLUS Binding Price Floors Must be set ABOVE the equilibrium price Elasticity of Demand Measures how buyers change their consumption in a good given the price of that good Typically represented by absolute values Classifying different price elasticity Price ELASTIC As long as the proportional percentage INCREASE of quantity numerator is greater than the proportional percentage DECREASE of the price denominator the value will always be 1 small rise in the price will lead to a larger percentage drop in demand and vice versa o Revenue Price x Quantity Sold When price decreases quantity goes up If quantity goes up more than price goes down revenue will increase Price INELASTIC If the absolute value of elasticity is 1 Decreasing the price of a good that is inelastic would not increase quantity demanded or revenue Price increases will increase revenue Percentage Change Expresses how big of change some quantity is when compared to the original value of that quantity o Start with the first value and divide it by the second Multiply that by 100 Determinants of Price Elasticity of Demand 2 factors o Number of substitutes available o Price of the good relative to one s budget Limited substitutes low price inelastic price of good Many substitutes higher price elastic price of a good More substitutes elastic Low price inelastic Linear Demand Curve Elastic demand flatter o Flatter the demand curve the more elastic a good o Steeper the demand curve the less elastic a good Other Elasticities Income elasticity of demand o Used to measure the relationship between income and demand o Percentage change of the quantity of good X in response to the percentage change in a buyers income o Tells you whether goods are Normal or Inferior When the income elasticity is greater than 0 we call the good consumed a normal good When income rises he will consume less of inferior goods Cross elasticity of demand o Measures the effect of the percentage change in the price of one good and the consumption of another good Percentage change in the quantity demanded of good X over the percentage change of good y Dictates complements and substitutes Complement goods an increase of price in one good will lead to a decrease in the consumption of others Substitute goods an increase of price in one good will lead to an increase in the consumption of its complements Price elasticity of supply o Measures the effect of a change in price on the quantity supplied by producers o Explains how suppliers of goods and services react to change in price o Percentage change of the quantity supplied of good X over the percentage price change of good X Time is a significant factor Price elasticity of supply tends to rise over time The Production Process Explains how firms operate in competitive markets o The Firm and Economic Profit o How to use resources effectively to produce output revenue resources opportunity cost economic profit o The Production Process Inputs are combined in some way to produce an output The production function the some way which uses variable inputs and fixed inputs to produce outputs Variable inputs easy to adjust Fixed inputs inputs in which the cost does not change based on the quantity of output produced The production function Marginal product is calculated by the change in output change in variable input Equal to the slope of the production curve Diminishing marginal returns At some level of input some marginal product begins to fall Will typically set in as more variable inputs are added to a fixed input The Cost of Production Short run day week The costs of certain inputs are fixed o Variable costs fixed costs total costs Long run year all input costs are variable o Variable costs total costs Sunk costs a cost that cannot be recovered once spent fixed Marginal cost of production how total costs increase as a firm increases output by one unit o Initially will fall then rise slowly followed by a rapid rise Marginal the change in variable cost Average variable costs of production o Calculated by dividing the variable costs by the level of output Cost curves o Average fixed cost falls with increased output Curve decreases as output increases o Average variable cost initially fall then actually increases with the increase of output Has a U shape The shape of the average cost curve is influenced by both o Marginal cost curve also has a U shape but also intersects both the fixed and variable cost curves at their lowest points In general when marginal cost is below the average cost average cost falls When marginal cost is about average cost average cost rises Referred to as the Efficient scale of production Marginal output is being produced at the