Exam 1 Flashcards
What is economic profit?
The difference between total revenue and total opportunity cost.
What is the importance of incentives?
All other things held constant, people are more likely to do something that has an incentive attached to it. Incentives affect how resources are used and how hard workers work.
What is marginal benefit?
The additional benefit that arise by using an additional unit of the item.
What is marginal cost?
The additional cost incurred by using an additional unit of the item.
What is the formula for the Present Value of a lump-sum future amount?
PV = FV/(1+i)^n
What is the formula for the Present value of a stream of future amounts?
PV = (FV/(1+i)^1) + (FV2/(1+i)^2) + … + FV/(1+i)^n
What is the formula for Present value of a perpetuity?
PV = [CF/(1+i)] + [CF/(1+i)^2] + [CF/(1+i)^3] + …
OR
PV = CF/i
What is a normal good?
A good for which an increase (decrease) in income leads to an increase (decrease) in the demand for that good.
What is an inferior good?
A good for which an increase (decrease) in income leads to a decrease (increase) in the demand for that good.
What is a substitute good?
Goods for which an increase (decrease) in the price of one good leads to an increase (decrease) in the demand for the other good.
What is a complement good?
Goods for which an increase (decrease in the price of one good leads to a decrease (increase) in the demand for the other good.
What is the formula for the inverse demand function?
Px = (Qdx - A)/alpha x
What is the formula for the inverse supply function?
Px = (Qsx - beta)/beta x
In the demand function, what is the test for substitute/complement?
alpha y >0 - substitute
alpha y <0 - complement
In the demand function, what is the test for normal/inferior good?
alpha m > 0 normal good
alpha m < 0 inferior good
In the demand function, what does alpha x indicate?
If alpha x is negative, then an increase in price will decrease quantity demanded.
What is consumer surplus?
The value consumers get from a good but don’t have to pay for it.
What is producer surplus?
The amount of producers receive in excess of the amount necessary to induce them to produce the good.
What is a price ceiling?
The maximum legal price that can be charged in a market.
What is own price elasticity?
A measure of the responsiveness of the quantity demanded of a good to a change in the price of that good; the percentage change in quantity demanded divided by the percentage change in the price of the good.
What is the definition of elastic demand?
Absolute value of own price elasticity is greater than 1
What is the definition of inelastic demand?
Absolute value of the own price elasticity is less than 1
What is the definition of unit elastic demand?
Absolute value of the own price elasticity is equal to 1
What factors determine elasticity?
availability of substitutes, expenditure share, and time
What is the relationship between revenue and demand elasticity?
Revenue is maximized when at unit elastic
What is cross-price elasticity?
A measure of responsiveness of the demand for a good to changes in the price of a related good; the percentage change in the quantity demanded of one good divided by the percentage change in the price of a related good.
What is income elasticity?
A measure of the responsiveness of the demand for a good to changes in consumer income; the percentage change in quantity demanded divided by the percentage change in income.
How do you find the market rate of substitution?
slope of the budget line
How do you find the marginal rate of substitution?
slope of the indifference curve
PROBLEM: A lotto winner can choose between a single lump-sum payout of $105M this year or $200M in 25 years. Assume that the interest rate is 3%. Which is the better deal?
Lump Sum
The manager of automated products is contemplating the purchase of a new machine that will generate revenue of $5000 for the next 5 years. Assume that the interest rate is 3%. What is the maximum price that he is willing to pay for the machine?
$22,898
What is the value of a firm that generates profit of $30,000 every year? Assume that the interest rate is 3%.
$1M
What is the equation for own price elasticity?
Eqxpx = alpha x (Px/Qx) OR (%changeQ/%changeP)
What is the formula for cross price elasticity?
Eqxpy = alpha y (Py/Qx)
What is the formula for income elasticity?
Eqxm = alpha m (M/Qx)
What number defines an elastic good? inelastic?
Absolute value of >1 is elastic
Absolute value of <1 is inelastic
If a company has an elastic good, what should it do to maximize revenue?
Decrease price
If a company has an inelastic good, what happens to the firms revenue when it decreases prices?
With price decreases comes revenue decreases
What is the indifference curve?
A curve that defines the combinations of two goods that give a consumer the same level of satisfaction.
What is the marginal rate of substitution?
The rate at which a consumer is willing to substitute one good for another good and still maintain the same level of satisfaction; the slope of the indifference curve.
What is the budget line?
The bundles of goods that exhaust a consumer’s income.
What is the market rate of substitution?
The rate at which one good may be traded for another in the market; the slope of the budget line.
Mkt rate of sub = -Px/Py
What is consumer equilibrium?
The equilibrium consumption bundle is the affordable bundle that yields the greatest satisfaction to the consumer.
The tangent point between indifference curve and the budget line when MRS=Px/Py
What is the formula for utility maximization condition?
MRS=Px/Py
