2.1 demand and supply analysis Flashcards
Economics
the study of production, distribution, and consumption
Macroeconomics
deals with aggregate economic quantities
Microeconomics
focuses on individual economic units
Demand and supply analysis is the key to microeconomics
Elasticity
the ratio of percentage changes and does not depend on the underlying units
inelastic demand
If demand is not very sensitive to price
This corresponds to an own-price elasticity between -1 and +1
unit elastic
elasticity is -1
the demand is elastic for lower quantities or higher quantities according to the linear demand curve
lower quantities
the demand is inelastic for lower quantities or higher quantities according to the linear demand curve
higher quantities
ith a vertical demand curve, the quantity demanded is the same regardless of the price. This is not possible at all prices, but it is often true over a specified price range
how elastic is this?
This means the demand is perfectly inelastic, which means it has zero elasticity.
A horizontal demand curve implies the consumers will buy an infinite amount at a given price, but zero at a price just a little bit greater. This is often true for perfectly competitive markets like the wheat market
how elastic is this?
The demand is perfectly elastic and thus has infinite elasticity
how does the existence of close substitutes impact own-price elasticity?
the own-price elasticity of demand is likely high
Consumers could just switch to a competitors’ product
If there are no close substitutes, then the demand will be much less elastic
If the product is a small portion of people’s budgets, then the demand elasticity is high or low?
low
people would not likely buy less toothpaste even if the price of toothpaste rises by 10%
The long-run demand is typically more elastic than the short-run demand
why?
Consumers have more time to adjust behaviors to changing prices. But this is not true for durable goods like washing machines. People would likely react to a drop in prices in the short-term but would not purchase more washing machines in the long run
When demand is elastic, the price and total expenditure move in opposite directions
what does this mean?
what about when demand is inelastic?
if the price decreases, the total expenditure will increase
This occurs because the percentage change in quantity is bigger than the percentage change in price
When demand is inelastic, the price and total expenditure move in the same direction
when will the total expenditure for a good or service be maximized?
at the quantity that is associated with the unit elastic point on the demand curve
Income elasticity of demand
the percentage change in the quantity demanded divided by the percentage change in income
Income elasticity can be negative, positive, or zero
normal goods
consumption goods have positive income elasticity
the quantity demanded will increase when income increases
inferior goods
goods with negative income elasticity
The cross-price elasticity will be positive or negative for close substitutes?
Positive
As the price rises on good Y, people will be inclined to purchase more of good X
The cross-price elasticity is positive or negative for goods that are complements?
Negative
These goods are normally consumed together
the substitution and income effect
When the price of a good like beef falls, people will tend to buy more beef than chicken. It is relatively cheaper than chicken, so the consumer will substitute beef for chicken
When the price of a good falls, it also leaves the consumer with more purchasing power or real income. Consumers will tend to buy more goods with this extra income. That is the income effect
Giffen goods
The income effect could overpower the substitution effect for some inferior goods. This means more of a good would be consumed as prices rise
The slope of the demand curve would be positive
Veblen goods
For some goods, a high price tag may drive consumer demand. This could be true for fancy jewelry or cars
positively sloped demand curves
For a negatively sloped linear demand curve, own-price elasticity is most likely:
A
highest at relatively high prices.
B
the same at all points along the curve.
C
highest at relatively high levels of quantity demanded.
A
highest at relatively high prices.
The shape of the demand curve for a good that is sold in a perfectly competitive market is most likely:
A
vertical.
B
horizontal.
C
upward-sloping.
B
horizontal.
In a perfectly competitive market, demand is perfectly elastic. In such conditions, the demand curve is horizontal because the same price is paid for any quantity sold. A seller cannot obtain a higher price than the market price because goods are perfect substitutes.
increasing marginal returns
each additional resource will produce an increasing amount of output
Firms can experience this as they add more labor to the production process that optimizes efficiency, taking advantage of specialization
the law of diminishing marginal returns
Each additional unit of input will produce a smaller amount of output
Accounting profit
net income. It equals revenue less accounting costs (or explicit costs)
Economic profit is also known as abnormal or supernormal profiit
the total revenue less economic costs (sum of accounting costs and implicit opportunity costs).
This measure of profit focuses on forward-looking depreciation, which is based on the opportunity cost of the fixed capital
Firms in a perfectly competitive environment are price takers
They operate with a perfectly elastic, horizontal demand curve
The total revenue equals the price times the quantity
The total revenue is linear, with the slope equal to the price per unit.
in a imperfect competition, profit is maximized when:
- The marginal revenue (MR) equals the short-term marginal cost (SMC)
- SMC is rising
in a perfect competition, profit is maximized when:
so profit is maximized when the price equals SMC.
Firms operating in a perfectly competitive environment may only expect to earn which type of profit
a normal profit
That means the economic profit is zero because the capital is just earning a rate commensurate with the risk
Profit above this point would attract competitors, which would drive the profitability down
Zero economic profit is still a positive accounting profit
he short-run average total cost (SATC) curve
defines the per-unit cost in the short run
It is dependent on the choice of technology, physical capital, and plant size
The long-run average total cost (LRAC) curve
derived from the SATCs available to the firm. For example, each SATC could utilize a different type of technology
how can a firm gain economies of scale
by growing provided the output increases faster than the inputs
when do diseconomies of scale occur
if the increase in output is slower than the increase in input
the minimum efficient scale (MES)
The minimum per unit cost is the dividing line between economies of scale and diseconomies of scale
Economies of scale can come from factors such as
Increasing returns to scale (increases in output are proportionately larger than increases in inputs)
Specialization in functions
Purchasing more expensive but more efficient equipment
Reducing waste
Better use of market information
Obtaining discounted prices on inputs from bulk purchases
Diseconomies of scale can come from factors such as:
Decreasing returns to scale
(increases in output are proportionately smaller than increases in inputs)
Cumbersome management
Duplication of business functions
Higher resource prices due to supply constraints
in the short run, maximum profit (or minimal loss) is determined when
marginal cost equals marginal revenue
To maximize long-run profit under perfect competition, a firm should operate at which level
the minimum efficient scale point
Economic profit is zero in the long run under perfect competition
A company that expects total revenue to be less than its total cost but greater than its total variable cost over the long term, will most likely:
A
exit the market.
B
continue operating.
C
temporarily suspend operations.
A
exit the market
When total revenue is sufficient to cover total variables costs but not the total cost, a firm can continue to operate in the short-run. However, if these conditions are expected to continue over the long term, the company should exit the market
