White Elasticity Slope change in Y change in X P2 P1 Q2 Q1 Price Elasticity of Demand change in Quantity Demand change in Price Midpoint formula for calculating E Q2 Q1 Q1 Q2 2 Q2 Q1 Q1 Q2 P2 P1 P1 P2 2 P2 P1 P1 P2 Example P Q 20 2p Calculate Elasticity between the price p 2 and p 3 When P is equal to 2 Q is equal to 16 When P is equal to 3 Q is equal to 14 13 16 30 3 2 5 10 30 1 3 When the price moves 1 there is 1 3 change in Quantity Point Slope Formula Percent change in Qd change in Quantity Price E x 1 Slope x P Q Percent change in Price Quantity Change in price Example Q 20 2p Elasticity when P 8 P 10 1 2Q 8 10 Q 4 Absolute Elasticity E AB AC Categories of Elasticity 1 Elasticity 0 Perfectly Inelastic 2 0 Elasticity 1 Inelastic 3 Elasticity 1 Unitary Elastic Maximum revenue occur 4 1 E Infinite Elastic when Demand is in Unitary Elastic Perfectly Elastic Elastic E 1 Unitary Elastic Inelastic Perfectly Inelastic Q 90 30p Elasticity when P 10 Elasticity 1 slope x P Q 1 1 3 x 30 90 1 2 Relationship between Elasticitty and Total Revenue TR PxQ If price rises then Quantitiy decreases So its not clear what happens to TR If Demand is inelastic when p increases TR increases If Demand is inelastic when p decreases TR decreases If demand is elastic when price increase TR decreases If demand is elastic when Price decreases TR increases Total Revenue will be maximized where Elasticity is at 1 Why Elasticity is at 1 Above below makes TR decreases in both side Example Q 100 4p What Price should the firm charge to maximize the TR Q 100 4p and Elasticity has to be 1 1 slope x P Q 1 p 12 5 Determination of Elasticity Availability of substitutes Ceteris Paribus the more the substitutes that are available the more elastic the demand Proportion of a consumer s budget that is spent on the good Ceteris Paribus the larger the proportion of a consumer s budget the more the elastic the demand The length of time that consumers have to adjust to a price change Ceteris paribus the longer consumer have to adjust to a price change the more elastic the demand Long Elastic Short inelastic Q 400 8p Find Elasticity when p 10 Slope 8 1 1 slope x P Q 8 x 10 320 1 4 Income Elasticity of Demand change in Q change in Income 0 normal good 0 inferior good Cross Price Elasticity change in Quantity of A product chane in Price 1 slope x P Q Production Production Function shows the maximum amount of output that a firm to produce from a given amount of inputs Q f L K L Labor K Capital Short Run period time in which at least one input is fixed set amount Capital is typically the fixed input Labor is variable Marginal Product Labor MP L The additional output that is produced when the firm has an additional unit of Labor MPL change in Q change in Labor Specialization Effect as you hire more workers they can specialize in certain tasks taking advantage of comparative advantage MRL increases Congestion Effect as you hire more workers each worker has less capital with which to work MPL decreases Law of Diminishing Marginal returns product As you add more and more of a variable input to a fixed output at same point the marginal product of the variable input decreases Short run costs of production Fixed cost FC costs that do not vary with output Variable Cost VC costs that do vary with output Total Cost TC FC VC Average Fixed cost AFC FC Q Average Variable Cost AVC VC Q Average Total cost TC Q AFC AVC Marginal Cost MC change in TC change in Q Marginal Cost the change in total cost that occurs when the firm produces on extra unit of output MC change in Total Cost change in Q Assume there are two inputs Capital K and Labor L and that we are in the short run so K is fixed Change in TC W wage rate x change of labor not changing the capital W wage rate Price of labor Change in Total Cost Change Q w x change Labor change in Q MC W MPL Diminishing Marginal Returns Increasing Marginal Cost If VC O when Q 0 then AVC MC at the first unit of output When marginal Average Average increases When marginal Average Average decreases As more to produce product decrease in the gap between AFC MC The marginal cost curves will intersect both the AVC and the ATC at their minimum Difference between AFC AVC ATC ATC AFC AVC ATC AVC AFC Long Run Production In the Long Run all inputs are variable Q f L K Returns to Scale What happens to Q if the firm doubles both of its inputs If output goes up by more than double Increasing returns to scale If output goes up by exactly double constant returns to scale If output goes up by less than double Decreasing Returns to scale Diseconomies of scale Returns to Scale Production Function Q f L K For t 1 any value greater than 1 If f t x l t x k t x f L K Increasing Returns to Scale Economies of scale If f t x l t x k t x k L K Constant Returns to scale If f t x l t x k t x f L K Decreasing Returns to scale Diseconomies of scale Long Run Average Total Cost LRAC TC Q If input prices w wage rate price of Labor r price of capital are constant TC wxl rxk Decreasing Returns to Scale Increasing LRAC Increasing Return to scale Decreasing LARC Constant Returns to scale Constant LRAC Example Increasing Returns to scale teaching in University 1 vs 1 more expensive Decreasing Returns to scale Pizza delivery more efficient Perfect Competition Assumption 1 Many buyers and sellers 2 Firm produce homogeneous identical product 3 Buyers and sellers have complete informative individuals face a perfectly elastic demand curve 4 Easy to enter easy to exit 5 No externalities 6 No transaction cost 7 No government interferes taxes regulation Total Revenue Px Q The change in total revenue that occurs when the firm changes output by one unit Change in TR change in price x Q1 Change in Quantity x P2 Marginal Revenue change in P x Q change in Q P In perfect competition for an individual firm P MR We assume that firms try to maximize profit Profit TR TC In order to maximize profit a firm should produce the quantity where MR MC This is a necessary condition for Profit maximization Suppose MR MC the firm can increase profit by increasing output Suppose MR MC the firm can decrease profit by decreasing output Only if MR MC can the firm be maximizing profits Perfectly competitive firms are …