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Micronomics Exam 2 Study GuideChapter 19: Demand and Supply Elasticity- Elasticity – measure of sensitivity between two variables- Price Elasticity of Demand – the sensitivity of the change in quantity demanded of a good in response to a change in the price of the good- *If demand is elastic, the quantity demanded for that good is very sensitive to price changes- Demand is ELASTIC when quantity demanded is relatively responsive to a change in the product’s own price – goods with A LOT of SUBSTITUTES- Demand is INELASTIC when quantity demanded is relatively unresponsive to changes in price– GAS, MEDICINE, TOILET PAPER (no substitutes)- Demand Elasticity – ED= %∆QD / %∆P < 0- If price increases (positive percent change), quantity demanded will decrease (negative percent change)- If price decreases (negative percent change), quantity demanded will increase (positive percent change)- %∆= new – old / old- *elasticity is unitlessNew Old Percent Change125 100 125 – 100 / 100 = 25/100 = 25%- Elasticity of Demand – do percent change formula twice (once for P and once for QD) then take a ratio to find price elasticity of demandPrice QuantityNew Old New Old Elasticity of Demand$4 $2 6 9 %∆QD= 6-9/9 = -3/9 = -1/3 / 1 = -33.3%%∆P = 4-2/2 = 2/2 = 1 ED= -1/3 – inelastic- Elastic Demand – ED < -1, “big” / “small”; quantity demanded is very sensitive to price changes- Inelastic Demand – -1< ED < 0, “small” / “big”; quantity demanded is NOT sensitive price changes- Unit Elastic Demand – ED = -1; same / sameo Even though elasticity will be different at all points, the demand curves we are looking at are all linear – same slope at all points- Point Elasticity – 1/slope * P/Q o P and Q are just any ordered pair on the actual demand curveo Slope is just the slope of the linear demand curve (found by comparing two points and doing “rise over run”o ED = (coefficient on price – Q=f(P)) * P/Qo Linear demand curve – as we move down ED becomes more inelastic (less elastic)- Total Revenues – TR = P*Q (width times height)o Maximized at the unit elastic priceo Demand is ELASTIC – Demand curve revenue can be increased by selling MORE units at a LOWER priceo Demand is INELASTIC – Demand curve revenue can be increased by selling LESS units at a HIGHER priceo Demand is UNIT ELASTIC – TR is already MAXIMIZED1Micronomics Exam 2 Study Guide- Special Demand Curves with Constant Elasticityo Perfectly elastic, infinitely elastic – ED = zero, horizontal slope – you will only buy this good at one price. Any increase in price means you will not buy this good (perfect substitutes, specific brand of gas)o Perfectly inelastic, zero elasticity – no matter what happens to the price, you’ll always buy the same amount of this good (medicine, drugs, insulin)o Special-shaped non-linear demand curve – elasticity is -1 at all points on the curve- Determinants of Price Elasticity of Demando Number of substitutes  More substitutes – elastic Les substitutes – inelastico Share of income spent on a good directly related to price elasticity of demand Car, house – elastic Gum, candies – inelastico Passage of time; Second Law of Demand states that demand is more responsive to price in the long run than in the short run (price of gas increases) Short run – consumption does not change very drastically (still buy gas) Long run – consumption can increase or decrease very drastically (bus, search for public transportation, bike, move closer to work)- More elastic; more time to adjust and find substitutes- Supply Elasticity – ES = %∆QS / %∆P > 0o Greater than 0 because supply curve is positively slopedo Long run – elastico Short run – inelastico Technology, capital use; in long run, we can use more capital with better technology – leads to lower marginal production costs- Income Elastic of Demand – the relative change in the quantity demanded of a good in response to a change in income. This will roughly measure how far the demand curve horizontally shifts when income changeso EI = %∆QD / %∆I > or < or = 0o Normal good – a good which we purchase MORE of when income increases, ceteris paribus Income elasticity of demand is positive (positive % increase in income, positive % increase in quantity demanded) Luxury – EI > 1 (designer clothes, nice restaurant) Necessity – 0 < EI < 1 (milk, toothpaste)o Inferior good – a good which we purchase LESS of when income increases, ceteris paribus Income elasticity is negativeo EI = 0 – medicine - Cross-price Elasticity of Demand – the relative change in the quantity demanded of a good in response to change in the price of ANOTHER good – horizontal shift in demando EXY = %∆QDX / %∆PY > or < or = 0o Two goods are substitutes – elasticity will be positiveo Two goods are complements – elasticity will be negativeo Two goods are unrelated – elasticity will be 02Micronomics Exam 2 Study GuideChapter 20: Consumer Choice- Utility is the satisfaction from consuming a good or service- Total utility is the TOTAL satisfaction resulting from the consumption- Marginal utility is the ADDITIONAL satisfaction obtained by consuming one more unit of a good- Marginal utility is diminishing – it decreases as we consume more and more of a goodo The first couple units of the good increase our happiness a lot. As we consume more, each additional unit will increase our happiness but not increase it as much as the previous unito The more we have of something, the less marginal utility each unit of that good brings us. If we have very little of something, consuming it will greatly increase our happiness- A unit of happiness is called a “util”- If goods are the same price, a person will choose the option with the highest marginal utility (MU)- When you purchase a good, the MU of that good decreases- For optimal spending – spend each additional dollar where it gives highest MU- MU and Different Priceso MUX / PX = MUY / PY o MU per dollarPrice of X ($)MUXPrice of Y ($)MUYWhat should Claudia do to her consumption?10 2 5 3 MUX / PX = 2/10 = 1/5 MUY / PY = 3/5 MUX / PX < MUY / PY – need to consumemore Y, less XChapter 21: Rents and Profits- Economic rent – a payment for the use of any resource over and above its opportunity costo Find the minimum amount you would have to pay a resource for its current use – rent is any payment it receives about that amounto


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PSU ECON 102 - Exam 2 Study Guide

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