A measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants
Price elasticity of demand
A measure of how much the quantity demanded of a good responds to a change in the price of that good.
How price elasticity of demand is calculated.
% change in quantity demand / % change in price
When is demand for a good elastic?
When the quantity demanded responds substantially to changes in price.
When is demand for a good inelastic?
When the quantity demanded responds only slightly to a change in price.
Do goods with close substitutes have a more elastic or inelastic demand?
Elastic demand because when the price of one good rises, consumers will switch to the other.
Do necessities or luxuries have more elastic demand?
Luxuries because people will give them up more easily when price goes up.
Are narrowly-defined or broad markets more elastic?
Narrowly-defined markets because it is easier to find close substitutes to narrowly-defined goods. (Food [broad] is inelastic, Ice cream [narrowly-defined] is elastic)
Do goods tend to have more elastic or inelastic demand over longer time horizons?
Some goods are inelastic over the short-term & more elastic in the long-term.
When elasticity is > 1, demand is considered...
When elasticity is = 1, demand is considered...
to have unit elasticity.
What is unit elasticity?
When the quantity moves the same amount proportionately as the price.
When the demand curve passing through a given point is flatter, is the price elasticity of demand smaller or larger?
The flatter the demand curve that passes through a given point, the greater the price elasticity of demand. The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand.
What is the elasticity of a vertical demand curve?
0. It is considered perfectly inelastic.
What shape is the demand curve when demand is perfectly elastic?
The demand curve is horizontal.
When elasticity is < 1, demand is considered...
What is the relationship between inelastic demand, price and total revenue?
Total revenue rises with an increase in price.
What is the relationship between elastic demand, price and total revenue?
Total revenue decreases with an increase in price.
What is total revenue (in a market)?
the amount paid by buyers and received by sellers of a good.
How do you calculate total revenue in a market?
Price of good x quantity sold
What is the relationship between unit elasticity, price and total revenue?
Total revenue remains constant with price changes.
What is income elasticity of demand?
a measure of how much the quantity demanded of a good responds to a change in consumers' income, computed as the percentage change in quantity demanded by the percentage change in income.
What is cross-price elasticity of demand?
a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good.
What is the price elasticity of supply?
a measure of how much the quantity supplied of a good responds to a change in the price of that good.
How is the elasticity of supply calculated?
% change in quantity supplied / % change in price
When is the supply of a good said to be elastic?
When the quantity supplied responds substantially to changes in the price.
When is the supply of a good said to be inelastic?
When the quantity supplied responds only slightly to changes in the price.
Is supply more elastic in the long or short run?
Over short periods of times, firms cannot easily change the size of their factories to make more or less of a good. Over longer periods, factories can be opened or closed so the quantity supplied can respond to price changes.
For low levels of quantity supplied at firms with limited capacity for production, what level is supply elasticity?
What conditions must a market meet to be competitive?
1) Identical goods
2) No single buyer or seller can influence the market price. Must be price-takers.
What is the law of demand?
Other things being equal, when the price of a good rises, the quantity demanded falls. When the price of the good falls, quantity demanded rises.
What is a normal good?
A good whose demand falls when income falls and rises when income rises.
What is an inferior good?
A good whose demand rises when income falls and falls when income rises.
What is the relationship between substitute goods and demand?
A fall in price for one good reduces demand for the other.
What is the relationship between complimentary goods and demand?
When there is a fall in price of one good, demand for the other increases.
What factors can cause movement on the demand/supply curve?
The only thing that can cause movement on the demand/supply curve is a change in price.
What is the Law of Supply?
Other things being equal, when the price of a good rises, the quantity supplied of the good increases. When the price of a good falls, the quantity supplied decreases.
Where is equilibrium?
intersection of supply and demand curves
What is the market-clearing price?
What is a surplus?
When quantity supplied is greater than quantity demanded. (excess supply, above the equilibrium)
What is a shortage?
When quantity demanded is greater than quantity supplied. (excess demand, below the equilibrium)
What is the law of supply and demand?
The price of any good adjusts to bring quantity supplied and demanded into balance.
What is total revenue for a firm?
The amount a firm receives for the sale of its output.
What is a firm's total cost?
The market value of the inputs a firm uses in production.
What is profit for a firm?
Total revenue minus total cost.
How do you calculate total revenue?
Quantity of output x price
What are explicit costs?
Input costs that require an outlay of money by the firm.
What are implicit costs?
Input costs that do not require an outlay of money by the firm (opportunity costs)
What is the relationship between total, explicit and implicit costs?
Total cost=explicit + implicit costs
What is economic profit?
Total revenue minus Total cost (includes both implicit and explicit costs)
What is accounting profit?
Total revenue minus Total explicit costs
What is a production function?
The relationship between quantity of inputs (workers) used to make a good and the quantity of output of that good.
What is the marginal product?
The increase in output that arises from an additional unit of input.
What is the diminishing marginal product?
The property whereby the marginal product of an input declines as the quantity of the input increases.
What happens to the total-cost curve as the amount produced rises?
The total-cost curve gets steeper.
What happens to the production function as production rises?
It gets flatter
What are fixed costs?
Costs that do not vary with the quantity of output produced.
How do you find the average total cost?
What is marginal cost?
The increase in total cost that arises from an extra unit of production.
How do you calculate marginal cost?
MC=Change in TC/Change in Q
What is the relationship between marginal cost and the quantity of output produced?
Marginal cost rises with the quantity of output. This reflects the property of diminishing marginal product.
What shape is the ATC curve?
What is the efficient scale?
The quantity of output that minimizes ATC.
Where does the efficient scale quantity occur?
At the lowest point of the ATC curve
What happens to the ATC when marginal cost is less than the ATC?
The ATC is falling.
What happens to the ATC when marginal cost is greater than ATC?
The ATC is rising.
Where does the marginal-cost curve cross the ATC curve?
At its minimum.
What are economies of scale?
The property whereby long-run average cost falls as the quantity of output increases.
What are diseconomies of scale?
The property whereby long-run average total cost rises as the quantity of output increases.
What are constant returns to scale?
The property whereby long-run average total cost stays the same as the quantity of output changes.
Why do diseconomies of scale often arise?
Because of coordination problems that occur in large organizations. The more output produced, the more stretched management becomes and the less effective they are at keeping costs down.
Why do economies of scale often arise?
higher production levels allow specialization which permits each worker to become better at a specific task.
Why are long-run ATC curves U-shaped?
ATC is falling at low levels of production because of increasing specialization and rising at high levels because of increasing coordination problems.
What is an externality?
The uncompensated impact of one person's actions on the well-being of a bystander.
What is a negative externality?
When the impact on a bystander is adverse.
What is a positive externality?
When the impact on the bystander is beneficial.
Why is the market equilibrium not efficient when there are externalities?
Because buyers and sellers neglect the external effects of their actions when deciding how much to demand or supply.
What is the social cost?
The private costs of aluminum producers plus the costs to those bystanders affected adversely by the externality.
What's another way to refer to the supply and demand curves (when talking about externalities?)
Where is the social cost curve in relation to the supply and demand curves?
Above the supply curve because it takes into account the external costs imposed on society.
Where is the social optimum point found on the graph (with negative externalities)?
The social optimum is where the Demand and Social cost curves intersect.
Why is the equilibrium quantity of goods produced larger than the social optimum quantity?
The inefficiency occurs because the market equilibrium reflects only the private costs of production.
What is internalizing the externality?
Altering incentives so that people take account of the external effects of their actions.
Where is the social optimum point on the graph (with positive externalities?)
Where the supply and social value curves intersect. The socially optimal quantity is greater than the quantity determined by the private market.
What is the best way for the government to internalize negative externalities?
Because negative externalities lead markets to produce a larger quantity than is socially desirable, the government taxes those goods.
Positive externalities lead markets to produce a smaller quantity than is socially desirable so the government subsidizes those goods.
What are corrective taxes?
A tax designed to induce private decision makers to take account of the social costs that arise from a negative externality.
What are corrective taxes also known as?
Pigovian taxes, after economist Arthur Pigou
What would the ideal corrective tax equal?
The external cost from an activity with negative externalities.
What would the ideal corrective subsidy equal?
The external benefit from an activity with positive externalities.
What is the Coase Theorem?
The proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.
What are transaction costs?
The costs that parties incur in the process of agreeing to and following through on a bargain.
What does excludable mean?
The property of a good whereby a person can be prevented from using it.
What is rival in consumption?
The property of a good whereby one person's use diminishes other people's use.
What are private goods?
Excludable and rival in consumption.
What are public goods?
Neither excludable nor rival in consumption.
What are common resources?
Rival in consumption, not excludable.
What are club goods?
Excludable, not rival in consumption
What is a free-rider?
A person who receives the benefit of a good but avoids paying for it.
What is a cost-benefit analysis?
A study that compares the costs and benefits to society of providing a public good.
What is the tragedy of the commons?
A parable that illustrates why common resources are used more than is desirable from the standpoint of society as a whole.
What is deadweight loss?
The fall in total surplus that results from a a market distortion, such as a tax.
What is consumer surplus?
The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.
What is producer surplus?
The amount a seller is paid for a good minus the seller's cost of providing it.
How does a competitive firm maximize profit?
By producing the quantity at which marginal cost = marginal revenue.
How does a monopoly maximize profits?
By choosing the quantity at which marginal revenue equals marginal cost, then uses the demand curve to find the price that will induce consumers to buy that quantity.
What is output effect on monopolies?
When more output is sold, quantity is higher which tends to increase total revenue.
What is the price effect?
The price falls which tends to decrease total revenue.
What is the relationship between price, marginal revenue and marginal cost for a competitive firm?
What is the relationship between price, marginal revenue and marginal price for a monopoly?
How do you find the monopolists' profit?
The height of the box is price minus ATC (point on demand curve above where MC & MR meet, point on ATC curve below that point).
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