Microeconomics Test II Study Guide Chapters 1 2 3 7 8 CHAPTER 7 CLASS NOTES Consumer Choice and Elasticity Elasticity of Demand law of demand states that if price P increase quantity demanded QD decreases elasticity gives us more information about the consumer price elasticity seeks to quantify how much QD falls price elasticity of demand change in QD change in P number will always come out negative disregard Values of Price Elasticity if elasticity 1 then elastic if E 1 then inelastic if E 1 then unitary elastic this means that consumers change their behavior a lot this means that consumers change their behavior a little this means that consumers don t change their behavior Key Point price elasticity is NOT the slope of the demand curve more substitutes more elastic more responsive What Determines Elasticity 1 availability of substitutes 2 share of budget greater share more elastic 3 times more time to shop around for more options more elastic a straight line demand curve will have a constant slope but a different elasticity at every point How Demand Elasticity and Price Changes Affect Total Expenditures or revenues on a Product total revenue TR to the firm is total expenditure TE by the consumer TR TE P x Q if an elastic good and price falls P x Q TR lower price and a lot more is bought Q dominates the equation if an elastic good and price rises P x Q TR raise price and a lot less is bought Q dominates the equation if an inelastic good and price falls P x Q TR lower price and a little more is bought P dominates equation if an inelastic good and price rises P x Q TR raise price and a little less is bought P dominates equation Income Elasticity price elasticity measures the change in consumer purchases when price changes income elasticity measures the change in consumer purchases when income I changes income elasticity change in QD change in I Values of Income Elasticity based on answer from above formula if positive consumers buy more when income rises normal good a good that consumers will buy more of when income rises if negative consumers buy less when income rises inferior good a good that consumers will buy less of when income rises ex name brand instead of generic ramen noodles Price Elasticity of Supply price elasticity of supply measures the responsiveness of quantity supplied to price changes how much does quantity supplied QS increase or decrease when price P rises or falls CHAPTER 8 CLASS NOTES Costs and The Supply of Goods The Economic Role of Costs economic profit does not equal accounting profit accounting profit total revenue total out of pocket costs economic profit total revenue total out of pocket costs opportunity costs zero economic profit is referred to as normal profit rate Short Run and Long Run Time Periods short run SR a period of time in which at least one input is fixed long run LR a period of time in which all inputs are variable none of the inputs are fixed Categories of Costs some costs are fixed they don t vary with quantity these are called fixed costs ex rent of building some costs are variable they vary with quantity these are called variable costs ex amount of money spent on spices average costs are per unit costs marginal cost is the change in total cost total cost TC fixed cost TFC variable cost TVC quantity Q TC Q ATC average total cost TFC Q AFC average fixed cost TVC Q AVC average variable cost Output and Costs in the Short Run the ability of a firm to make stuff its production is intimately tied to costs in this chapter must understand why cost curves look the way they do and how they are related to production Why does marginal cost first fall and then rise rapidly because of diminishing marginal returns at some point each additional input adds less to total output than the previous input since more and more of input is required marginal cost rises rapidly What is the relationship between marginal cost MC and average total cost ATC ex GPA a student with a 3 0 cumulative GPA ATC semester GPA is 3 5 MC now cumulative GPA rises ATC rises next semester GPA is 2 0 MC now cumulative GPA is lower ATC falls next semester GPA is 2 5 MC ATC still falls because the average chases the margin Output and Costs in the Long Run long run average total cost LRATC is U shaped why does LRATC look like this in order to produce larger quantities a firm will need to get bigger and therefore increase their capital these are typically expensive to do so capital costs become large which drives up the LRATC Economies of Scale economies of scale means the benefit is getting bigger ATC also referred to as increasing returns to scale diseconomies of scale means the benefit is negative ATC referred to as decreasing returns to scale Summary in the SR diminishing returns determine the shape of the cost curves in the LR economies of scale determine the shape of the cost curves What Factors Cause Cost Curves to Shift higher costs shift curves up 1 resources more expensive 2 higher taxes 3 more stricter regulations 4 older technology lower costs shift curves down 1 resources less expensive 2 lower taxes 3 less regulations 4 newer technology Cost Curves Impact Supply Curves when cost curves should be ignored sunk costs these costs cannot be reversed or recovered therefore sunk costs should be ignored but not forgotten when making decisions about the future Keep Thinking on the Margin continue to engage in an activity as long as the expected marginal benefit is greater than the expected marginal cost CHAPTER 7 VOCAB law of diminishing marginal utility the basic economic principle that as the consumption of a product increases the marginal utility derived from consuming more of it per unit of time will eventually decline marginal utility the additional utility or satisfaction derived from consuming an additional unity of a good marginal benefit the maximum price a consumer will be willing to pay for an additional unit of a product it is the dollar value of the consumer s marginal utility from the additional unit and therefore it falls as consumption increases substitution effect that part of an increase decrease in amount consumed that is the result of a good being cheaper more expensive in relation to other goods because of a reduction increase in price income effect that part of an increase decrease in amount consumed that is the result of the consumer s real income being expanded contracted by a reduction rise in the price of a good price elasticity of demand the
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