Chapter 2 Flashcards
Opportunity Cost
Opportunity costs represent the potential benefits that an individual, investor, or business misses out on when choosing one alternative over another.
Because opportunity costs are unseen by definition, they can be easily overlooked.
Public Good
A good or service that, once purchased by anyone, can of necessity be enjoyed by many.
Marginal cost.
The cost of producing an extra unit.
Ceteris Paribus
(cet. par.)
When analysing one variable, the convention that all other variables are held constant.
Inferior Good
An inferior good is one for which the quantity purchased decreases when real income increases.
Normal goods
Good which when income increases the quantity also increases.
Complementary Good
A good whose demand curve shifts along with that of another good.
Substitute Good
A good whose demand curve shifts inversely with that of another good.
What is the difference between marginal cost and opportunity cost?
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Law of demand
When Price rises → the quantity demanded falls
Two reasons explain this: Income effect and substitution effect
=The income effect of a price rise
people feel poorer and they cannot afford to buy so much with the same income as they used to.) so their purchasing falls.
Substitution effect of a price rise
Because goods are now costing more than alternative or substitute goods, people will then switch to those.
Quantity demanded
the amount of a good that a consumer is willing and able to buy at various prices over a given period of time.
Demand schedule for an individual
a table showing the different quantities of a good that a person is willing and able to buy at various prices over a given period of time.
Market demand schedule
the total quantities of the demand schedule.
Demand curve
a graph showing the relationship between the price of a good and the quantity of the good demanded over a given time period.
Price is measured on the vertical axis; quantity demanded is measured on the horizontal axis.
A demand curve can be for an individual consumer or group of consumers, or more usually for the whole market.
Determinants of Demand
Demand is affected by the following:
- Tastes
- The number and price of substitute goods. These are goods considered by consumers to be alternatives to each other. As the price of one goes up, the demand for the other rises.
- The number and price of complementary goods. These are goods consumed together. As the price for one goes up, the demand for both will fall.
- Income - Normal goods = a good whose demand rises as people’s income rise.
- Inferior goods = a good whose demand falls as people’s income rise.
Distribution of income. - Expectation of future price changes.
Change in demand
the term used for a shift in the demand curve. It occurs when a determinant of demand other than price changes.
Increase rightward shift
Decrease leftward shift
Change in the quality demanded
The term used for a movement along the demand curve to a new point. It occurs when there is a change in price.
Change in price movement along curve
Formula for the price elasticity of demand
PeD = %∆Qd / %∆P
So percentage change in quantity demanded divide by the percentage change in price.
Elasticity is measured in percentage terms for the following reasons:
It allows changes in two qualitatively different things, which are this measured in two different types of unit (allows comparison of quantity changes with monetary changes.
It is the only sensible way of deciding how big a change in price or quantity is.
When is a demand elastic/inelastic?
Elastic when e > 1
Where a change in price causes a relatively larger change in the quantity demanded. Therefore, customers are very sensitive to a change in the price.
Inelastic when e < 1.
Where a change in price causes a relatively smaller change in the quantity demanded. The customers a relatively insensitive to a change in the price.
Unit elastic when e = 1.
It occurs when price and quantity demanded change by the same proportion.
What determines price elasticity of demand?
The number and closeness of substitute goods. (the most important determinant)
The proportion of income spent on the goods. The higher the proportion of our income we spend on a good, the more we will be forced to cut consumption when its price rises: the bigger will be the income effect and the more elastic will be the demand.
The time period. When price rises, people may take time to adjust their consumption patterns and find alternatives. The longer the time period after the price change the more elastic the demand is likely to be.
Total consumer expenditure
(TE) = P x Q
TE is TR which is total revenue
Elastic If P rises; Q falls proportionately more; thus, TE falls
Elastic If P falls; Q rises proportionately more; thus, TE rises
When demand is inelastic, price changes proportionately more than quantity. Thus, the change in price had a bigger effect on total consumer expenditure than does the change in quantity.
Inelastic If P rises; Q falls proportionately less; TE rises
Inelastic If P falls; Q rises proportionately less; TE falls
Totally inelastic demand
vertical straight line
Infinitely elastic demand
horizontal straight line.
At any price above P1, demand is 0.
Unit elastic demand
Where price and quantity change in exactly the same proportion. Any rise in price will be exactly offset by a fall in quantity, leaving total consumer expenditure unchanged. The curve is a rectangular hyperbola.
The average (or midpoint) formula
∆Q / average Q
∆P/ average P
Point elasticity
The measurement of elasticity at a point on a curve. The formula for price elasticity of demand using the point elasticity method is ∆Q/ ∆P X P/Q . Where ∆Q/∆P is the inverse of the slope of the tangent to the demand curve at the point in the question.
Price elasticity supplied
The responsiveness of quantity supplied to a change in price.
%∆Qs%∆P
Determinants of price elasticity of supply?
The amount that costs rise as output rises.
Time period
Immediate time period: highly inelastic.
Short run: supply can increase somewhat.
Long run: highly elastic.
Income elasticity of demand (Yed)
the responsiveness of demand to a change in consumer incomes.
Yed = % change in demand / % change in income
Yed = %∆Qd%∆Y
Cross-price elasticity of demand (Cedab)
The responsiveness of demand for one good to a change in the price of another.
Cedab = % change in demand for good A / % change in price for good B.
Cedab = %∆Qda%∆Pb
Normal goods - E
Goods whose demand increases as consumer incomes increase. They have a positive
income elasticity of demand. Luxury goods will have a higher income elasticity of demand than more basic goods.
