19. Microeconomics Flashcards
What is microeconomics?
Deals with price and cost of manufacturing goods, and the reactions of suppliers and customers.
What affects the position and slope of the price against quantity demand curve?
- Price of goods
- Consumers income
- Substitutes and complements
- Fashion and taste
- Essential vs luxury (price doesn’t affect demand as much for essential goods compared to luxury goods)
- Expectation of future price changes (consumers thinking price will rise soon causes higher demand)
What does elastic demand mean?
When small prices changes cause large change in demand.
What does inelastic demand mean?
When change in price has relatively little effect on demand.
What is the price elasticity of demand defined as?
The proportional (or percentage) change in demand ÷ The proportional (or percentage) change in price
What does a price elasticity of demand greater than 1 indicate?
That a relatively small change in price will cause a relatively large change in demand (elastic)
What does a price elasticity of demand less than 1 indicate?
That a relatively small change in price will cause a relatively small change in demand (inelastic)
What does a price elasticity of demand equal to 1 indicate?
That revenue will be constant if price is changed slightly.
What are the two approaches to calculate elasticity?
- Arc elasticity
- Point elasticity
How do you calculate elasticity using point elasticity?
This uses the starting price as our basis point.
For this example, price starts at P1 and moves to P2, while quantity starts at Q1 and ends at Q2:
- Find absolute change in price P2-P1
- Use this to find proportionate change in price absolute change ÷ P1
- Do the above steps for quantity (Q2-Q1) ÷ Q1
- Convert both decimals to positive if they are negative
- Divide proportionate change in quantity by proportionate change in price ((Q2-Q1)÷Q1)÷((P2-P1)÷P1)
- The result is the price elasticity of demand
How do you calculate elasticity using arc elasticity?
This uses the mid point between two quantities as our basis point.
For this example, price starts at P1 and moves to P2, while quantity starts at Q1 and ends at Q2:
- Find mid point of price change (P1+P2)÷2
- Use this to find proportionate change in price (P2-P1)÷((P1+P2)÷2)
- Do the above steps for quantity (Q2-Q1)÷((Q1+Q2)÷2)
- Convert both decimals to positive if they are negative
- Divide proportionate change in quantity by proportionate change in price ((Q2-Q1)÷((Q1+Q2)÷2))÷((P2-P1)÷((P1+P2)÷2))
- The result is the price elasticity of demand
What is income elasticity of demand?
Measures how demand varies with income
What is income elasticity of demand defined as?
Proportional change in demand ÷ Proportional change in income
What is a product called if it’s income elasticity of demand is negative?
Inferior goods
What are inferior goods?
- Where the income elasticity of demand is negative
- Means people switch to different brands as their income increases
What does an inelastic (0 to 1) income elasticity of demand represent?
Necessities
Goods bought when income is low or high
What does an elastic (greater than 1) income elasticity of demand represent?
Luxuries
More purchased when income increases
What is the relationship of price and quantity (supplied/demanded) in a supply curve compared to demand curve?
Supply curve
- As price increases, supply increases
- Production is ramped up as there are more opportunities for profit when price is high
Demand curve
- As price increases, demand decreases
Profits are only made if the goods produced actually sell, so an equilibrium is reached where demand is matched by supply
What is the market price of a product?
The equilibrium point where demand is matched by supply
What causes a rightward shift in the demand curve?
- Rise in income
- Rise in price of substitutes
- Rise in expected price of the product
- Reduction in price of complements
- Change in tastes/fashion
- Population increase
What does a rightward shift in demand curve represent?
More demand for a product at any given price point
What does a rightward shift in supply curve represent?
More products supplied at any given price point
What causes a rightward shift in supply curve?
- Fall in production costs
- Fall in price of other goods
- Technology changes
- Subsidies
- Lower tax
What are the two types of cost?
- Fixed costs
- Variable costs
What are fixed costs?
Costs that don’t vary in short term as production increases
Eg factory rent
What are variable costs?
Costs that increase with production volume
Eg labour costs
What happens to the average fixed cost (fixed cost per unit) as production costs increase?
Average fixed cost decreases
- Constant fixed costs are spread over more units
What happens to average variable cost (variable cost per unit) as production increases?
Goes down initially as it’s more efficient, but goes back up again due to diminishing returns.
Eg machines become more expensive to run at the highest output
What is the average total cost?
Sum of averaged fixed cost and average variable cost
What is the marginal cost?
The cost of producing one more unit
Always crosses over the minimum point of the average variable cost curve and the average total cost curve
What are the types of competition?
Perfect competition
&
**Imperfect competition*”
- Monopolist
- Oligopoly
- Monopolistic competition
What is perfect competition?
- Where there are many small buyers and seller
- No buyer or seller is large enough to affect the market
- Free entry and exit from the market
What is Monopoly?
- Only one supplier
- They can set price at any level but volume demanded will change
What is Oligopoly?
- Small number of suppliers
- If supplier raises price, the others will win market share by sticking to old price
- If supplier lowers price, others have to follow to maintain market share
What is Monopolistic competition?
- Firms increase demand using methods other than price
- eg brand and reputation
