Exam 2 Chapters 4 7 Price Elasticity of Demand how much the buyers buy at a certain price Elasticity measured in percentages percentage change in quantity percentage change in demand change in Q change in P Ex If price of gatorade increases by 25 the quantity demanded will decrease by 50 because there are a lot of substitutes for gatorade E 50 25 2 Inelastic always negative because the demand curve is negative Elasticity coefficient less than one Inelastic equal to one unit elastic more than one elastic The more vertical the demand line the less elastic it is inelastic demand curve for natural gas The amount that buyers buy does not really depend on the price because consumers have such a high demand for that item The supply curve is usually inelastic not straight it is a curved line Price elasticity is different at each point E P Q 1 slope slope is the same for the demand curve P Q decreases as price goes down and quantity goes up E change in Quantity change in price Elastic Substitutes If Inelastic don t care about price Price Elasticity is always negative The more vertical the slope the more inelastic Price and quantity have inverse relationship Ex Price goes up quantity goes down If price goes down quantity goes up Perfectly Inelastic slope is zero perfectly vertical line Perfectly Elastic horizontal line Revenue P Q Ex If a toll cost 1 trip and there are 100 000 trips E 2 should they raise price of toll by 10 2 x 10 change Q 20 Rev1 1 100 000 100 000 Rev2 1 10 80 000 88 000 Therefore total rev decreases by 12 000 dollars and so they should not raise the price of tickets by 10 Cross price elasticity of demand the percentage change in quantity demanded of good A from a 1 change in the price of good B Ex Apples and oranges If the price of apples goes up the quantity demanded or oranges goes up Income elasticity of demand the percentage change in quantity demanded from a 1 change in income complements have a negative cross price elasticity substitutes have a positive cross price elasticity Positive income elasticity is a normal good Negative income elasticity is an inferior good Law of Demand people do less of what they want to do as the cost of doing rises at lower prices people do more and higher prices people will do less needs require for subsistence for survival We have unlimited wants but we have limited resources money income wealth time and energy Utility the satisfaction people derive from consumption cannot be compared between people Cost benefit if the cost of doing activity is greater than benefit you stop doing it Law of Diminishing Marginal Utility tendency for additional utility gained from consuming an additional unit of good to decrease as consumption increases beyond some point Marginal utility can increase at low levels of consumption Eventually marginal utility declines continue consuming Apply cost benefit principle consume an additional unit as long as marginal utility benefit is greater than marginal cost Rational Spending Rule spending should be allocated across goods so that the marginal utility per dollar is the same for each good EX Manny has a weekly allowance of 24 Pizza is 6 and Movie Rental is 3 Pizza 0 1 2 TU week MU 0 20 36 MU P 20 16 3 33 2 66 Movie Rental 0 1 2 0 40 46 TU week MU MU P 40 6 13 3 2 48 58 66 72 76 78 3 4 5 6 7 8 It will benefit manny the most to buy 3 pizzas 18 and 2 movie rentals 6 24 Total utility 48 46 94 Marginal utility per dollar is the same for each good the rational spending rule 1 33 1 33 2 3 1 3 0 0 2 1 66 1 33 1 2 3 1 3 12 10 8 6 4 2 50 54 56 57 57 57 3 4 5 6 7 8 4 4 2 1 0 0 Consumer Surplus difference between the buyer s reservation price and the market price Buyer reservation price the highest price the buyer is willing and able to pay EX The buyer s reservation price for a loaf of bread is 3 50 The market price is 50 cents at 50 cents the bakery is able to sell 100 loaves of bread Therefore the buyer has 3 00 left over To find consumer surplus you do 1 2 B H 1 2 100 3 150 Cost benefit principle continue an activity if and only if the marginal benefit is greater than or equal to the marginal cost MB MC If marginal benefit is greater than marginal cost then you continue to do that activity Important Formulas TC FC VC ATC TC Q AVC VC Q MC change in TC change in Q P MR MB If P ATC profit if P ATC loss if P AVC should shut down Profit P ATC x Q OR profit Revenue Cost Revenue P x Q Sellers cannot determine the price to sell a product they can only decide how much to produce at the market price accounting profit total revenue explicit costs explicit costs are payments firms make to purchase resources and products Economic profit the difference between total revenue and the sum of its explicit and implicit cost EX 1 Should Pudge continue farming or quit if he quits earns 11 000 year working in retail explicit costs are 10 000 total revenue is 22 000 Accounting profit total revenue explicit cost 22 000 10 000 12 000 Economic profit total revenue explicit cost implicit cost 22 000 10 000 11 000 1 000 therefore he should continue farming because his economic profit is positive normal profit accounting profit economic profit 12 000 1 000 11 000 Economic profit in the long run is always zero in a perfectly competitive industry P MC ATC Consumer surplus is the triangle above the equilibrium point and producer surplus is below it To find their units just use the formula to find the area of a triangle 1 2 base height Sometimes a price ceiling is attached to certain items meaning that the producers cannot sell their product over that price Having this price ceiling makes change in your graph and surpluses Due to this price ceiling some surplus is lost and no one is able to use it
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