TEST 2 STUDY GUIDE REVIEW QUESTIONS CHAPTER 7 Consumer Choice and Elasticity Elasticity of demand Price Elasticity measures the change in consumer purchases when price changes Elasticity gives us more information about the consumer Price elasticity seeks to quantify how much quantity demanded falls or rises The firms are the one who really want to know what the elasticity is They need to know this Ask yourself by how much does price need to rise to decrease quantity demanded by x By how much does price need to fall to increase quantity demanded by Y Price elasticity of demand percentage change in quantity demanded pecentage change in price Values if Elasticity 1 then elastic consumers change behavior a lot if E 1 then inelastic consumers change behavior little if E 1 then unitary elastic consumers don t change behavior PRICE ELASTICITY IS NOT THE SLOPE OF THE DEMAND CURVE a straight line demand curve still has a diff elasticity at every point If a good is elastic a higher price will cause consumers to spend less on that good less total revenue for the firm A lower price will cause consumers to spend more on the good more total revenue for the firm If a good is unitary elastic a higher or lower price wont change how much the consumer spends on it If a good is inelastic a high price will make consumers spend more money on it more total revenue for the firm and a low price will make consumers spend less on the product less total revenue on the product Income Elasticity Income elasticity measure the change in consumer purchases when income changes If positive consumer buy more when income rises If negative consumers buy less when income rises Normal Good A good that consumers will buy more of when income rises Inferior good a good that consumers will buy less of when income rises Economic profit total revenue total costs Zero economic profit referred to as normal profit rate CHAPTER 8 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 i e none of the inputs are fixed Categories of Cost fixed costs don t vary with quantity variable costs vary with quantity average costs are per unit costs marginal cost is the change in total cost if I invite one more person to the party how much more total cost will it be Why does Marginal Cost first fall and then rise rapidly falls for two reasons o Increasing marginal return each additional input of production adds more to output than the previous input o Learning by doing workers gain experience and become better at what they are doing MC rises because of diminishing marginal returns At some point each additional input adds less to total output than the previous input Since more and more import is required marginal cost rises rapidly Economies of scale means the benefit is getting bigger Average Total Cost is falling Diseconomies of scale means the benefit is negative ATV is rising Cost curves impact supply curves When cost curves shift up supply shifts left When cost curves shift down supply shifts right Sunk Costs Sunk costs cannot be reversed or recovered Therefore they should be ignored when making decisions Keep thinking on the margin The link between resource and product markets What s the relationship between product markets and resource input markets CHAPTER 4 an increase decrease in demand for a product will increase decrease demand for resources that make product When the product price rises the resource price will eventually rise The Economics of Price Controls Two kinds of price control Price ceiling puts an upper limit on price generates a shortage and a deadweight loss Price floor puts a lower limit on price generates a surplus and a deadweight loss Deadweight loss DWL loss of gains from trade The loss from the elimination of mutually beneficial exchanges from the imposition of a tax in a market The Impact of a Tax Statutory incidence who is legally responsible to pay the tax This is the tax burden it hinders exchange This is an administrative detail that is mostly irrelevant Actual incidence who really pays the tax this is the more important issue the burden is shared between firms and consumers Ways to analyze if the tax is legally imposed on sellers shift the supply curve if the tax is legally imposed on buyers shift the demand curve Regardless of who the ta is legally imposed on the graph for the revenue is pretty much the same What determines how the burden of the tax is shared The size of the deadweight loss and the actual burden depend on supply and demand elasticity You don t need to remember a lot Inelastic steep o o Elastic flat o The inelastic member of the market pays the most of the tax Do companies really pay taxes In order for the company to be in business it must hire people and collect revenue from people No only people pay taxes The company is just an intermediary for the government to collect tax revenue example suppose the elasticity indicates that the consumer pay 40 of the tax and the company pays 60 Who really pays the 60 Employees suppliers wholesalers owners investors of the company Tax Rate value tax a percent is applied to the sales price per unit amount is applied to each unite sale example 1 for every unit sold Graphical representation of the relationship between the tax rate and revenue Starting at high tax rates an increase in the tax rate may actually lower revenue o in this case larger revenue may be generated by lowering tax rates Tax Revenue rate X sales The Laffer Curve Chapter 5 What does efficiency mean The largest net benefit is achieved Rule engage in activity so long as the expected marginal benefit is greater than the expected marginal cost Have you ever said to yourself that s good enough When cleaning something when studying for an exam when completing a task etc Perfection is not usually a desirable result Potential Shortcomings of the Market Markets will usually generate an efficient outcome sometimes they may not Why 4 possible reasons o 1 A lack of competition if there are only a few firms then supply may be restricted which will lower the quantity available and raise price o 2 Poor information poor information results in poor decision making o 3 Public goods a public good has two characteristics Many people can consume the good simultaneously non rival People who do not pay for the good can still consume it non excludable Because of its characteristics it will hard to generate funds for public goods
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