Class 3: Economic Foundations

Question 1

What is willingness to pay?

Answer 1

• Price where buyer is indifferent on buying or not buying it
• Not necessarily what the buyer wants to pay or “fair” price
• Depends on multiple factors including tastes, income, substitutes, WTP, etc

Question 2

What does a demand curve show?

Answer 2

How many (Q) would be purchased at a price (P)

Question 3

Why do demand curves slope downward?

Answer 3

The cheaper it is, the more you will sell

Question 4

What is market demand?

Answer 4

The sum of the demand of individual buyers or businesses at each price

Question 5

What is price discrimination?

Answer 5

Charging different prices to different buyers for the same product in order to claim more economic value

Question 6

What does the slope of the demand curve measure?

Answer 6

How responsive buyers are to the changes in prices

Question 7

What does demand elasticity equal?

Answer 7

percent change in quantity divided by percent change in price

Question 8

Why is time a critical component for demand?

Answer 8

demand may be inelastic in the short run until alternatives are developed

Question 9

Elastic Demand

Answer 9

Luxury items, vacations, high-end electronics, even coffee are examples of elastic goods/services and have a very elastic demand

Question 10

Inelastic Demand

Answer 10

Staple foods, medicine, spices have an inelastic demand. A price change has little impact on the quantity demanded by consumers, necessities, few or no substitutes

Question 11

Why is the price elasticity of demand a potentially imperfect measure?

Answer 11

1) Super hard to measure on people
2) Slope varies at different parts of curve
3) The percent change from 10 to 15 and 15 to 10 (both 5 units), is quite different on a percentage basis

Question 12

How do firms decide how to supply on the short-run?

Answer 12

based on their marginal costs

Question 13

What are fixed costs?

Answer 13

Expenses that must be paid if in business, unrelated to quantity of production. Examples: building depreciation, insurance, rent, full-time salaries, technology, interest expense, property taxes, CEO (sunk costs)

Question 14

What are Marginal costs?

Answer 14

Expenses that vary in direct proportion to the quantity of production. Examples: print-outs, raw materials, packaging, manufacturing related labor, utilities, maintenance and repair, incremental machinery

Question 15

What should firms do in the short-run?

Answer 15

firms should produce as long as the price meets or exceeds the marginal costs

Question 16

What do marginal costs include?

Answer 16

cash costs and opportunity costs

Question 17

What are opportunity costs?

Answer 17

Forgone alternatives, benefit not received bc the alternative choice was not taken

Question 18

What is the marginal cost curve?

Answer 18

the short run supply curve of the an individual firm

Question 19

What are fixed-costs in the long-run?

Answer 19

avoidable, so are critical factors when entering/exiting a market

Question 20

What do fixed costs include?

Answer 20

both out of pocket expenditures and opportunity costs of capital

Question 21

When the firm “breaks even” what does it mean?

Answer 21

what it is spending

Question 22

What does the average cost include?

Answer 22

both fixed and marginal costs, usually a u shaped curve, at the bottom of the U, firm is producing most efficiently

Question 23

Explain the shape of the U curve

Answer 23

In the beginning, fixed costs are high, but then bottom out, and then marginal costs get high

Question 24

When will a firm enter a market?

Answer 24

Only when it expects the average market price to be be higher than the minimum average cost

Question 25

Explain this situation in terms of fixed and marginal costs: Tesla is building gigafactory at a cost of 5 billion in fixed costs. Why does this make sense?

Answer 25

Tesla assumes that they will incur high fixed costs at in the beginning which is a very expensive move in the short-run. However, this is an investment in an economy of scale in production of gigafactory production of batteries, which will allow them to produce at a higher volume and eventually get their marginal costs lower, leading to higher profit in the long-run

Question 26

Explain this situation in terms of fixed and marginal costs: A restaurant in Buckhead stays open an extra two hours, even though it is only one third full

Answer 26

Rent is a high fixed cost that the restaurant will have to pay no matter if they stay open or not. Rent is expensive in buckhead, so it makes more sense for the restaurant to try to sell as much volume as possible, even if they’re not at capacity, to meet and exceed their margins.

Question 27

What is market supply?

Answer 27

sum of the quantity supplied by all firms at a given price

Question 28

What happens to the market supply at the lowest prices

Answer 28

Only the efficient producers continue to operate, and the quantity supplied is low

Question 29

What happens to the market supply as prices rise?

Answer 29

Incumbents produce more and new firms join. The less efficient firms are at the top right of the supply curve

Question 30

What does the price elasticity of supply depend on?

Answer 30

the flexibility

Question 31

Describe the high price elasticity of supply curve

Answer 31

a flat supply curve, a small increase in price drives a lot of new output. Usually seen in facilities where production can easily be switched over, ie house rental during the Masters at Augusta

Question 32

What is the price elasticity of supply over the long term?

Answer 32

like demand curves, they are more elastic over the long term. capacity can be added and new suppliers may enter the market

Question 33

What is market equilibrium determined by?

Answer 33

overlaying demand and supply curves. When there is excess demand, supply is lower and then price is higher. When there is excess supply, demand is lower and then price is lower.

Question 34

Explain the price elasticity of supply of oil

Answer 34

Breakeven costs varies quite a bit among oil sands so entry and exit prices vary, you can’t just turn oil operations off and on, so it is too expensive to constantly be exiting and entering. Due to this, price elasticity of supply is relatively inelastic.

Question 35

In India, how did Reliance Jio Impact average data prices?

Answer 35

Cheaply introduced data to entire country. As overall prices went down, demand went up, which enticed new entrants, leading to more competition and then prices falling farther down

Question 36

How do increases in supply and demand shift the curves?

Answer 36

An increase in supply shifts the curve to the right, dropping the price. An increase in demand shifts the curve to the right, increasing the price

Question 37

Explain change in demand versus as shift in demand

Answer 37

Change in demand: Ambani does/doesn’t invest 35 billion, so people do/don’t demand something so they don’t care
Shift in demand: shift in supply leads to shift in demand

Question 38

Explain short-run and long-run response in the price elasticity of supply

Answer 38

In the short-run, higher demand typically is shown in higher prices. In the long run, higher demand is typically shown in greater supply

Question 39

What is the reality of the markets?

Answer 39

Markets are imperfect so it’s critical to understand the underlying assumptions, an example of an imperfect market is the healthcare market