ECON Notes Flashcards
How individuals
(consumers & firms) make choices (i.e.,
how do people make optimal decisions)
Optimization
How markets and
nonmarket institutions produce
outcomes in individuals’ decisions (i.e.,
what are the outcomes we observe
when individuals are making those
optimal decisions)
Equilibrium
Assumptions
Individual are _____________ & ___________
rational and act purposefully
Individuals maximize a measure of _______-______
Subject to some sort of _________ due to _______ resources
well-being (happiness, profit)
constraint, scare (budgets)
max (B(x) - C(x))
x is an activity level
B is the benefits received from that activity level
C is the costs you incur from the activity at level x
What is the law of demand
As price increase which is on the y axis quantity demanded decreases which explain the downward slope of the demand curve
Four key determinants of demand
- Preferences
- Price and availability of related
goods - Income
- Number of consumers (for market
demand)
Draw the demand curve for Q = 4-2P
P = 2 - 0.5Q
At a price of 0 the quantity demand is 4
When the quantity demanded is 0 the price is 2
Measures the sensitivity to changes in the environment
Elasticity
What is demand elasticity?
What is the formula?
When is it elastic, unit elastic, and inelastic
How much will quantity demanded change when price changes by x%?
Formula: %ΔQ/%ΔP
Elastic: -1:-infinity
Unity Elastic: -1
Inelastic: -1:0
What is the law of supply?
As the price increases the quantity supplied increases as well which explains the upward sloping supply curve
Determinants of Supply
Input prices (raw materials, labor)
➢ Technology (quality and availability)
➢ Alternative product lines
➢ # of firms in the market(more firm = more supply)
➢ Price and supply of joint products (ex:
as the demand/price of beef falls,
supply of leather falls)
➢ Time frame(firms can increase supply more in the long run than the short run)
Draw a supply curve for Q=2P-20
What happens if price is 20?
P=10+0.5Q
What is Supply elasticity
What is the formula?
What is inelastic, unit elastic, and elastic
Measures a firms’ sensitivity to price changes
Formula: %ΔQ/%ΔP
Inelastic: 0:1
Unit Elastic: 1
Elastic: 1:infinity
_________ is one of the most important factors influencing supply elasticity
Why?
Time
In the long run firms can change supply more than in the short run
What are the four main assumptions for competitive markets?
- Many consumers & firms on both sides of the
market
a. “Price Takers”: No one has the power to
unilaterally set prices - Common knowledge
a. The market has a free flow of information - No collusion
a. Firms cannot explicitly cooperate to
affect prices and quantities in the market - Free entry & exit
a. Firms enter and leave the market as they
find it profitable to do so
b. Lack of technical/leg
What is market equilibrium
Where the supply and demand curve intersect
Example for market equilibrium
QD = 260-20P
Qs=32P-104
P=8
P=6
P=7
P=13-0.05QD
P=3.25 + 0.03125QS
P=7 equilibrium
How to find competitive equilibrium
I. P = 20 – 2QD
II. QS = P – 5
Set the equations equal to each other when both equation are at QD=QD and P=P
Solution
In equilibrium, QS = QD
➢ P – 5 = 10 – 0.5P
3. Solve for P
➢ 1.5P = 15
➢ P = 10
4. Substitute P into either the demand or supply curve to find Q
1. QD = 10 – 0.5(10) = 5
2. QS = 10 – 5 = 5
Benefit from
obtaining a product at a price less
than the maximum willingness to pay
Consumer surplus
Benefit from selling
at a price greater than minimum
required
Producer Surplus
Calculate Consumer surplus
Demand: QD = 260 – 20P
Supply: QS = 32P - 104
Equilibrium: P = 7, Q = 120
Consumer Surplus = 360
Producer Surplus = 225
Consumers willing to pay more than it
costs society to produce
A “_________ __________” occurs when resources are not efficiently allocated in the market
An example of what can cause this is in markets owned by a
__________
deadweight loss
monopolist
Let’s suppose a monopolist with a
cost per unit of $2 faces a demand
curve of P = 10 – Q
Supply curve is flat @ $2
Instead of selling 8 units @ 2 ($16 total
revenue), they can raise the price to $6
and sell 4 units ($24 total revenue) –
but you can see there is lost value to
the market because there were less
units sold
Not sure on how to do this yet
What is the income effect
As income grows, we demand more
What is the substitution effect
As prices increase and income stays the same, demand decreases
How to find the total demand curve for a market
Example
Jose’s preferences for Coca Cola yield this demand curve: QJ = 4 – 2P
Kayla’s preferences yield this demand curve: QK = 3 – P
➢ Total Market Demand: Q = 7 - 3P
What are ways to learn about the demand in a market for a firm and what is the best way?
Marketing surveys
Ask people what they’d pay!
However, what people say and do can be different
Price experimentation(best way)
Test effects of small changes in the market
Econometric studies
Very tricky to do properly
What causes a change in demand (3 things)
Response to change in price
Response to related Goods
Substitutes ( A & B are substitutes A increases, buy more of B)
Complements (C & D are complements, C increases, buy less of D)
Response to Income
Normal Goods
Inferior Goods
Luxury Goods
_________ changes along the demand curve
elasticity
What determines elasticity for demand? (5 things)
Similarity of Substitutes (coke vs Pepsi)
Market Definition (coke vs all soda vs all drinks)
Timeframe (short vs long run)
Importance/frequency (5% increase in car price vs Starbuck coffee(inelastic))
Tastes (Under Armour vs Nike)
Important tool in evaluating whether two products are in the same market
cross price elasticity
Income elasticity formula
Normal goods elasticity number
Inferior goods elasticity number
Formula: %ΔQx/%ΔI
Normal goods: EI > 0
Inferior goods: EI < 0
Marginal revenue formula
(change in revenue)/change in quantity
Let’s say we have a monopolist with a
demand function of:
* P = 200 – 0.25Q or Q = 800 – 4P
P1 = 50
What is quantity demanded and what is the amount of revenue
Q1 = 600
R1 =30,000
Let’s say we have a demand curve
of P = 200 – 0.25Q
* Revenue is (P x Q) = (200 – 0.25Q) x Q
Marginal Revenue is P + (dP/dQ) x Q
What is the marginal revenue formula
= (200 – 0.25Q) – (0.25) x Q
= 200 – 0.5Q (quick method:
just multiply the coefficient in
front of the Q by 2 – this only
works for linear demand curves,
but that is all we will cover in
this course)
- Demand Curve: P = 200 – 0.25Q
What is marginal revenue formula
What is the revenue maximizing quantity
Marginal Revenue = 200 – 0.5Q
* Set Marginal Revenue = 0; 0 = 200 – 0.5Q; Q* = 400 (revenue maximizing
quantity)
* P* = 200 – 0.25 x 400 = $100
* R* = 100 x 400 = $40,000
* We can confirm Q* = 400 by trying different Quantities…
* At Q = 404; P = $99 and Revenue = $39,996
* At Q = 396; P = $101 and Revenue = $39,996
What is the easiest type of market to analyze
monopolies
Charging different customers different prices for either:
price discrimination
Three requirements for price discrimination:
- Firm must have market power (competitive firms cannot charge different prices
for the same product, they are price takers) - Firm can identify at least two market segments with different elasticities
- Firm can enforce price differences (consumers targeted for the higher price
cannot pay the lower price instead)
How does a firm obtain information on differences among customers?
Ask customers about characteristics and vary price based on customer’s
response
* Issues: can be illegal (i.e., protected classes, determining price based on race,
etc) and customers have an incentive to lie
* Design a menu of products and customers voluntarily sort themselves
“Perfect” price discrimination
* The firm has complete information about
each consumer’s tastes
* Consumer is charged the maximum price
they would pay
* Charge each consumer the maximum they
would pay
* Firm serves all consumers willing to pay a
price above $0
* Consumers retain no surplus, and
deadweight loss is 0
*This is basically impossible in practice, but
other forms of price discrimination share some
characteristics
first-degree price discrimination
A firm can divide their consumer base into two groups
* Based on some easily identifiable attribute like zip code or age
* The two groups have different demand curves and the firm charges different prices to
each group
* Some examples would be special prices for kids, students or seniors
third-degree price discrimination
second-degree price discrimination
A firm cannot force consumers into groups that pay different prices
* Consumers vary in their private tastes
* Firm is unable to observe these differences before purchase
* Consumers must be convinced to “reveal” their private information
Examples on second-degree and third-degree price discrimination in slides
Look them up Week 2 Lesson 2.4
- Firms charge a fixed fee (F) for the “right” to purchase a product and p per
unit purchased - Can be viewed as second-degree price discrimination
- If you buy Q units, your total payments are T(Q) = F + pQ
- Examples: Golf Club membership plus green fees for each round
- Examples: PSL (personal seat licenses) for sports teams: pay an up-front
fee for the “right” to buy season tickets
Two-part tariffs
- If you have 1,000 high preference customers and 25 low preference
customers, it’s likely better to charge the ______-preference customers their
consumer surplus as a fee - If you have 1,000 low preference customers and 25 high preference
customers, it’s likely better to charge the ____-preference customers their consumer surplus as a fee
high
low
Look up example in slides on two-part tariffs for tennis club
Week 2 Lesson 2.5
Labor (high-skill, low-skill), Capital (machines, computers,
buildings…), and Other items (raw materials, land, etc.)
Inputs
What goods and services to produce (and how much of each to
produce)
Outputs
Can be varied immediately
* Need more to produce one more unit
* “Variable inputs”
Examples?
Labor
Electricity or number of people working
Can’t change immediately
* Don’t need more to produce one more unit
* “Fixed inputs”
Examples?
Capital
Building or equipment
What is the production function?
Q = f(L,K,…)
Q = quantity
L = Labor
K = Capital
We can describe production technology with a graph, with lines called _________
that show the variety of ways that certain output goals can be achieved
What does this graph look like?
isoquants
Capital, K is on the y axis
Labor, L is on the X axis
The same number of units can be produce with varying combinations of _________ and _______
capital and labor
What is the extra output from adding another unit of L, holding K fixed?
Marginal Product of Labor (MPL)
Marginal product of labor formula
dQ/dL
Average product of labor
Q/L also called labor productivity
If Marginal product of Labor > Average product of labor
What happens to average product of labor?
If Marginal product of Labor is < Average product of labor
What happens to average product of labor?
It goes up
It goes down
For higher levels of capital, we will observe what with marginal product of labor?
We will observe higher product of marginal product of labor
What is Marginal Rate of Technical Substitution?
Holding the quantity fixed, it is how much capital a firm is willing to give up for one more unit of labor.
The example in the lecture was if RSM has 1,000 computers but only one accountant, they would be willing to give up a lot of computers for one more accountant.
Marginal Rate of Technical Substitution formula
= - (MPL / MPK), the slope ofan isoquant
Scale economies
asking how much output increases if inputs increase by some factor
If inputs were to double when looking at Scale Economies
What is it called when we get double the output?
What is it called when we get more than double the output?
What is it called when we get less than double the output?
constant returns to scale
Increasing returns to scale
decreasing returns to scale
Most real-world technologies are believed to have ____________________________ for low Q, ___________________ for high Q
increasing returns to scale
decreasing returns to scale
Costs that are actually incurred (i.e., costs that would
show up on a company’s financial statements)
accounting costs
Costs relevant for decision-making (may or may not
show up on a company’s financial statements)
economic costs
where are opportunity costs included
economic costs
Where are sunk costs included
accounting costs
Why are sunk costs not included in economic costs
Regardless of the action taken a sunk cost has already incurred so it would be the same for the two possible actions in the future
When firms have more _________- in optimization, they can achieve their goals at lower expense
flexibility
What costs are fixed in the short run
Only capital (K) is fixed in the short run
What costs are variable in the long run?
All costs are variable in the long run so that mean labor and capital are variable
What costs are variable in the short run?
Labor (L) is variable in the short run
What is the formula for Isocosts?
C = wL + rK
This might look confusing but let’s break it down
C is the total costs
w is the wage rate per unit of lab
L is the labor
r is the rent rate per unit
K is the capital
What is the profit formula for a firm?
Profit = PQ - wL - r*K
P = price the firm charges
Q = the quantity that it supplies and is bought
w = the wage rage
L = labor hours
r = rental rate per unit
K = total capital
