ARE 201 1st EditionExam # 2 Study Guide Chapters 5-7Chapter 5- Many economic questions depend on the size of con- sumer or producer responsesto changes in prices or other variables. Elasticity is a general measure of responsiveness that can be used to answer such questions. - The price elasticity of demand—the percent change in the quantity demanded divided by the percent change in the price (dropping the minus sign)—is a measure of the responsiveness of the quantity demanded to changes in the price. In practical calculations, it is usually best to use the midpoint method, which calculates percent changes in prices and quantities based on the average of starting and final values. - The responsiveness of the quantity demanded to price can range from perfectly inelastic demand, where the quan- tity demanded is unaffected by the price, to perfectly elastic demand, where there is a unique price at which consumers will buy as much or as little as they are of- fered. When demand is perfectly inelastic, the demand curve is a vertical line; when it is perfectly elastic, the de- mand curveis a horizontal line. - The price elasticity of demand is classified according to whether it is more or less than 1. If it is greater than 1, demand is elastic; if it is less than 1, demand is inelastic; if it is exactly 1, demand is unit-elastic. This classification determines how total revenue, the total value of sales, changes when the price changes. If demand is elastic, total revenue falls when the price increases and rises when the price decreases. If demand is inelastic, total revenue rises when the price increasesand falls when the price decreases.- The price elasticity of demand depends on whether there are close substitutes for the good in question, whether the good is a necessity or a luxury, the share of income spent on the good, and the length of time that has elapsed since the price change. - The cross-price elasticity of demand measures the effect of a change in one good’sprice on the quantity of another good demanded. The cross-price elasticity of demand can be positive, in which case the goods are substitutes, or neg- ative, in which case they are complements. - The income elasticity of demand is the percent change in the quantity of a good demanded when a consumer’s income changes divided by the percent change in in- come. The income elasticity of demand indicates how in- tensely the demand for a good responds to changes in income. It can be negative; in that case the goodis an inferior good. Goods with positive income elasticities of demand are normal goods. If the income elasticity is greater than 1, a good is income-elastic; if it is positive and less than 1, the good is income-inelastic. - The price elasticity of supply is the percent change in the quantity of a good supplied divided by the percent change in the price. If the quantity supplied does not change at all, we have an instance of perfectly inelastic supply; the supplycurve is a vertical line. If the quantity supplied is zero below some price but infinite above that price, we have an instance of perfectly elastic supply; the supply curve is a horizontal line. - The price elasticity of supply depends on the availability of resources to expand production and on time. It is higher when inputs are available at relatively low cost and the longer the time elapsed since the price change. - The tax revenue generated by a tax depends on the tax rate and on the number of units transacted with the tax. Excise taxes cause inefficiency in the form of deadweight loss because they discourage some mutually beneficial transactions. Taxes also impose administrative costs: resources used to collect the tax, to pay it (over and above the amount of the tax), and to evade it. - An excise tax generates revenue for the government but lowers total surplus. The loss in total surplus exceeds the tax revenue, resulting in a deadweight loss to society. This deadweight loss is represented by a triangle, the area of which equalsthe value of the transactions discouraged by the tax. The greater the elasticity of demand or supply, or both, the larger the deadweight loss from a tax. If either demand or supply is perfectly inelastic, there is no dead- weight loss from a tax. Chapter 6- The relationship between inputs and output is a producer’s production function. In the short run, the quantity of a fixed input cannot be varied but thequantity of a variable input can. In the long run, the quantities of all inputs canbe varied. For a given amount of the fixed input, the total product curve showshow the quantity of output changes as the quantity of the variable input changes. We may also calculate the marginal product of an input, the increase in output from using one more unit of that input. - There are diminishing returns to an input when its marginal product declines as more of the input is used, holding the quantity of all other inputs fixed. - Total cost, represented by the total cost curve, is equal to the sum of fixed cost, which does not depend on out- put, and variable cost, which does dependon output. Due to diminishing returns, marginal cost, the increase in total cost generated by producing one more unit of output, normally increases as output increases. - Average total cost (also known as average cost), total cost divided by quantity of output, is the cost of the average unit of output, and marginal cost is the cost of one more unit produced. Economists believe that U-shaped average total cost curves are typical, because average total cost consists of two parts: average fixed cost, which falls when output increases (the spreading effect), and average variable cost, which rises with output (the diminishing returns effect).- When average total cost is U-shaped, the bottom of the U is the level of outputat which average total cost is minimized, the point of minimum-cost output. This is also the point at which the marginal cost curve crosses the average total cost curve from below. Due to gains from specialization, the marginal cost curve may slope downward initially before sloping upward, giving it a “swoosh” shape. - In the long run, a producer can change its fixed input and its level of fixed cost. By accepting higher fixed cost, a firm can lower its variable cost for any given output level, and vice versa. The long-run average total cost curve shows the relationship between output and average total cost when fixed cost has been