Chapter 6 I ELASTICITY Elasticity a measure of how much one economic variable responds to changes in another economic variable Price Elasticity of Demand P E D The responsiveness of the quantity demanded Elastic demand percentage change in quantity demanded is greater than the percentage change in price absolute value P E D 1 Inelastic demand percentage change in quantity demanded is less than the percentage change in price absolute value P E D 1 Unit Elasticity demand is unit elastic when the percentage change in quantity demanded is equal to the percentage change absolute value P E D 1 P E D 0 price P E D Infinity Perfectly Inelastic Demand quantity demanded is completely unresponsive to price and the price elasticity of demand equals zero Perfectly Elastic Demand the quantity demanded is infinitely responsive to II Determinants of Elasticity of Demand 1 Available substitutes If a product has more substitutes available it will have more If a product has few substitutes available it will have less elastic elastic demand demand 2 Passage of time The more time that passes the more elastic it becomes because customers take time to adjust to buying habits 3 Luxury vs necessity Luxury is more elastic than necessity 4 Market size The smaller we define a market the more elastic demand it has 5 How much it is of a consumers budget The demand for a good will be more elastic the larger percentage it is of an average consumers budget III Total Revenue Total amount of funds received by seller Price x units sold total rev IV Cross Price Elasticity of Demand The percentage change in quantity demanded of one good divided by the percentage change in the price of another good If Cross price elasticity calculated number o Positive products are substitutes o Negative products are complements V Income Elasticity of Demand Measures the responsiveness of quantity demanded to changes in income If I E D is Positive but less than 1 normal good and necessity Positive but more than 1 normal and luxury good Negative inferior good VI Price Elasticity of Supply The responsiveness of quantity supplied to a change in price Same rules as P E D refer to page 1 and 2 VII Summary Chapter 11 Short run and Long run Economics Short run the period of time during at least one of a firms input is Long run period time in which all of a firms inputs vary new tech fixed location size 1 Costs Total cost TC the cost of all inputs firms use in production o Total cost variable costs fixed costs TC FC VC Fixed costs FC costs that remain the same o No fixed costs in the long run Average Fixed Costs AFC fixed costs divided by the quantity of output produced Variable costs VC costs that change as output changes o In the long run all costs are variable Average Variable Costs ATC variable cost divided by the quantity of output produced Explicit costs a cost that involves spending money Implicit costs a non monetary opportunity cost Average total cost ATC total cost divided by the quantity of output produced o TC Q ATC Marginal Costs MC the change in a firms total cost from producing one more unit of a good or service o Marginal cost of production falls then rises because the marginal product of labor rises then falls o Marginal cost Change in total cost Change in quantity Summary of symbols and formulas 2 Product of Labor Marginal product of labor the additional output a firm produces as a result of hiring one more worker o when the marginal product of labor is rising the marginal cost of o when the marginal product of labor is falling the marginal cost of output is falling production is rising Law of Diminishing returns Principle that if you keep adding an input such as labor to the same fixed capital the marginal product will decline o Ex hiring an increasing amount of worker to a food truck eventually each worker will produce less Average Product of Labor The total output produced by a firm divided by the quantity of workers 3 Economies of Scale Long Run Average Cost Curve LRAC shows the lowest cost at which a firm is able to produce a given quantity of output in the long run Short Run Average Cost Curve shows the lowest cost at which a firm is able to produce a given quantity of output in the short run Economies of Scale fall as it increases the quantity of output it produces the situation when a firm s long run average costs Diseconomies of Scale average cost rises as the firm increases output the situation in which a firms long run Constant returns to scale average costs remain unchanged as it increases output scale are finished Minimum efficient scale the situation in which a firms long run the level of output at which all economies of
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