Elasticity a measure of how responsive one variable is to change in another variable calculated as the percentage change in quantity divided by the percentage change in price 1 Price of elasticity of demand measure change in Q w change in its own price 2 Cross price elasticity measures change in Q w change in another good s price 3 Income elasticity measures change in Q w change in income Types MIDPOINT FORMULA 1 Price Elasticity of Demand equation A measure of how responsive quantity demanded is to a change in price Elastic An increase in price leads to a large decrease in the quantity demanded Inelastic An increase in price leads to a small decrease in the quantity demanded normal good SUMMARY OF PRICE ELASTICITY TYPES 2 Cross Price Elasticity of Demand equation A measure of the effect of a change in the price of one product on the quantity demanded of another calculated as the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good Substitutes goods services or resources that are viewed as replacements for one another Complements goods services or resources that are used or consumed w one another Ec 0 postive Ec 0 negative 3 Income elasticity of demand equation A measure of how responsive demand is to a change in consumer income Normal goods services or resources that are consumed more when income increases Inferior goods services or resources that are used or consumed less when income increases Ei 0 positive Ei 0 negative If the change in price is 20 and the change in quantity demanded is 10 what type of elasticity is present If the price elasticity of demand for a product is it is considered elastic Private market A market in which the demand and supply curves represent the benefits and costs to only the consumers and producers in the market Social external market a market in which the demand and supply curves represent the benefits and costs to everyone Externality the beefit enjoyed by or cost imposed on a third party not directly involved in the production or consumption of a good or service Types of externalities Positive The unpaid benefit enjoyed by a third party not directly involved in the production or consumption of a good or service Negative The uncompensated cost imposed on a third party not directly involved in the production or consumption of a good or service Market Failures MBprivate MCprivate Private vs Social Examples EXAMPLES GRAPHICALLY Types of goods 1 Public Nonrival Nonexcludable 2 Private Rival Excludable 3 Common Resource Rival Nonexcludable 4 Club Nonrival Excludable Nonrival Rival Examples Nonexcludable Excludable The characteristic of some goods or services whereby the consumption of the good or service by one person does not diminish the amount available to someone else Sometimes referred to as nonrival in consumption A characteristic of some goods or services whereby people cannot easily be prevented from consuming the good or service even if they don t pay for it Sometimes referred to as nonexcludable in consumption Tragedy of the Commons Free rider problem When a good is nonexcludable people will choose to consume the good without paying for it making it difficult for private companies to profitably provide the good Examples Solutions 1 2 3 Market Failure a situation in which a market fails to produce the efficient level of output that maximizes total surplus Property Rights the exclusive right to determine how a resource is used Coase Theorem If a property right is well defined and transaction costs are low resources will naturally gravitate to their highest valued use regardless of who owns the property right Coase Theorem Assumptions 1 Low Transaction Cost 2 Clearly defined property rights 3 Mutal agreement 4 Whoever values it more gets it For negotiations to eliminate an externality to be successful Utility the satisfaction or happiness received from the consumption of goods and services Consumer Choice Measured in Utils Total Utility the total satisfaction or happiness received from the consumption of a good service or combination of goods and services Marginal Utility The additional satisfaction or happiness received from the consumption of an additional unit of a good or service EXAMPLE Law of Diminishing Marginal Utility A principle in economics that states that the marginal utility associated with consumption of a good or service becomes smaller with each extra unit that is consumed in a given time period Utility Maximization How much should consumers use buy Assumptions of Decision Making 1 Rational Behavior 2 Ranked Preferences 3 Limited Income 4 Know Prices Mistakes in Decision Making 1 Opportunity cost is incorrect forgotten 2 Overconfident 3 Unrealistic about future and future behavior 4 Unequally valuing money 5 Loss Aversion 6 Focus on Status Quo Equal Marginal Principle The idea that consumers maximize their utility when they allocate their limited incomes so that the marginal utility per dollar spent on each of their final choices in a bundle is equal Budget Line A line showing the different combinations of two products that can be purchased with a given budget and at a known set of prices Equation Graphs Indifference Curves A curve that shows the combinations of two products that generate the same amount of total utility or satisfaction Indifference Curve Rules 1 2 3 4 Indifference Curves never cross the farther out an indifference curve lies the higher the utility it indicates indifference curves always slope downwards indifference curves are convex Consumption Bundle Total amount of goods and services that an individual consumes The ability to product to provide satisfaction is known as If total utility is decreasing marginal utility Production Costs EX Short Run Vs Long Run Explicit Monetary payments made by individuals firms and governments for the use of land labor capital and entrepreneurial ability owned by others Also known as accounting costs Implicit The opportunity costs of using owned resources costs for which no monetary payment is explicitly made Opportunity Cost The value of the next best forgone alternative The main difference between long run and short run costs is that there are no fixed factors in the long run there are both fixed and variable factors in the short run In the long run the general price level contractual wages and expectations adjust fully to the state of the economy In the short run these variables do not always adjust due to