gg Flashcards
- Concept of Opportunity Cost and how it is measured?
The cost of doing something is what we have to give up to do that
what does scarcity mean in economics?
here are limited amounts of goods and services, resources, time.
- Difference between Positive and Normative economics
-Normative Economics are based on subjective opinion and may not always be
verifiable
-Positive Economics refers to “objective statements” that are verifiable based on
theory or empirical evidences.
PPF
An economic model showing
possible combinations of outputs, given the full use of inputs and
technology
- What is the economic implication of the PPF?
PPF communicates the essence of Economic decision making in an
environment of “Scarcity” and the related ideas of Trade-off and
Opportunity Cost
- Opportunity Cost along the PPF
Opportunity Cost tells us “To increase the production of Laptop by 1 unit
how many units of cellphones need to sacrificed, if all the resources are
utilized efficiently”
Graphically, the slope of the PPF corresponds to the Opportunity Cost
W h y i s t h e D e m a n d C u r v e D o w n w a r d
s l o p i n g ?
Substitution effect: When the price of a good reduces it makes the
good relatively cheaper compared to its substitutes and urges
consumers to buy more of it
* Income effect: When the price of a good falls it implies the money that
you have gains “purchasing power” – you can buy more goods with
the same amount of money
Price effect = Substitution effect + Income effect
* Diminishing Marginal Utility: As people consume more of a good
during a fixed time, the satisfaction received from each additional unit
decreases
What happens to the Demand curve of a product when the price of the product changes?
[Movement along the Demand curve]
f the price changes (all other factors remaining unchanged), we
should move along the demand curve
When Price increases Move upward : Decrease in Quantity Demanded
When Price drop Move downward: Increase in Quantity Demanded
What happens to the Demand curve of a product when the non-price factors of the product
change? [Shift the Demand curve
Price remaining fixed, if any “Non-price” Demand factor changes,
then the Demand curve can shift
∆ (Change) in taste or preference
∆ in Consumer’s Income
oNormal good
oInferior good
∆ in the Price of Related goods
o∆ in the price of a substitute
o∆ in the price of a complement
∆ in the Number of Buyers
∆ in Expected future prices
Distinction between Change in ”Quantity Demanded” (Movement along the demand curve) and
”Change in Demand” (Shift in the Demand curve)
normal good
Definition: A good whose demand increases as individual’s income
increases. (Given price and other factors are unchanged)
* Increase in Income will cause a Rightward shift in the Demand curve
* Decrease in Income will cause a Leftward shift in the Demand curve
how is market demand obtained from Individual Demand?
The overall or total demand for a good,
service, or resource. It represents the summation of individual demand
curves, whether they represent individuals, communities, states, or
nations.
What is meant by Normal good and Inferior good?
normal good-A good whose demand increases as individual’s income
increases. (Given price and other factors are unchanged)
* Increase in Income will cause a Rightward shift in the Demand curve
* Decrease in Income will cause a Leftward shift in the Demand curve
inferior good-In economics, an inferior good is a good whose demand decreases when consumer income rises This is unlike the supply and demand behavior of normal goods, for which the opposite is observed. Inferior goods are often considered less desirable or lower quality than their alternatives
What is meant by Substitute good and Complementary good?
When the price of a good X increases, and it leads to decrease in
quantity demand for good Z. Then good Z is a complement for
good X.
* For example: If the price of coffee goes down it leads to higher
demand for sugar. In this case sugar and coffee are complementary
goods
When the price of a good X increases, and it leads to increase in
the demand for good Y. Then good Y is a substitute for good X.
* For example: If price of pizza rises from $4 to $6 then Steven
decides to buy sandwiches worth $5. So, for Steven, sandwich is a
substitute for pizza.
Price and Non-price determinants of Supply
A change in product price only with all other factors remaining
same is a Movement along Supply curve
* Increase in Price => Increase in Quantity Supplied (Movement upward)
* Decrease in Price => Decrease in Quantity Supplied (Movement
downward)
* A change in non-price factor price-level remaining same is a Shift in
the Supply curve
* Increase in Supply => Rightward Shift
* Decrease in Supply => Leftward Shift
- What causes a movement along the supply curve and what causes a shift in the supply curve?
As the price of the product rises; sellers will sell more quantity of the product and vice
-versa and this change takes place along the Supply curve
* If any Non-price Supply factor changes (price remaining fixed) it will be shown as a
Shift in the Supply curve
Price Elasticity of Demand
: A measure of the responsiveness of
quantity demanded to changes in price.
The coefficient of price elasticity of demand (Ed)
Ed = percentage change in quantity demand / percentage
change in price
Income Elasticity of Demand:
A measure of the
responsiveness of quantity demanded to changes in income.
§EY = percentage change in Demand/ percentage change
in income (Y)
Cross Elasticity of Demand
: A measure of the responsiveness in quantity
demanded of one good to changes in the price of another good.
Ec = percentage change in Demand of Good X/ percentage change in the price of
good Y
Why does the Price Elasticity of Demand have a negative sign?
The price elasticity of demand is always negative because price and quantity demanded move in opposite directions1234. A positive percentage change in price implies a negative percentage change in quantity demanded, and vice versa
- How does the Demand curve’s shape vary with the Price Elasticity’s value?
Perfectly Elastic Demand Curve:
Horizontal shape.
Consumers are extremely responsive to price changes.
Even a small change in price leads to an infinite change in quantity demanded.
Example: Commodity markets with identical goods.
Demand Curve:
Relatively flat.
Consumers are responsive to price changes, but not as extreme as in a perfectly elastic curve.
Small price changes result in proportionally larger quantity changes.
Examples: Luxury cars, vacations, designer clothing.
Unitary Elastic Demand Curve:
Constant price elasticity of demand value of 1.
Percentage change in quantity demanded equals percentage change in price.
Total revenue remains constant.
Examples: Staple foods (bread, milk), basic utilities (electricity).
Inelastic Demand Curve:
Steeper slope.
Consumers are less responsive to price changes.
Quantity demanded changes proportionally less.
Examples: Medications, gasoline, utilities.
Perfectly Inelastic Demand Curve:
Vertical shape.
Consumers are completely unresponsive to price changes.
Quantity demanded remains constant regardless of price fluctuations.
Examples: Life-saving medications, critical medical procedures
What happens to the Total Revenues when the Price is changed in the ”Inelastic” zone of the Demand curve?
Larger increase in total revenue
What happens to the Total Revenues when the Price is changed in the ”Elastic” zone of the Demand curve?
Raising total revenue
What factors determine the Price elasticity of demand for a good?
Presence of substitutes
○ Category of the good
○ Time duration for consumer’s adjustment
○ Proportion of Income spent on the good
What does the Sign of the Income Elasticity indicate about the nature of a Good? [Normal or Inferior]
the sign of the income elasticity helps us classify goods as normal, inferior, or luxury based on how their demand responds to changes in income. Positive elasticity indicates normal or luxury goods, while negative elasticity points to inferior goods
How does the Sign of the Cross-price elasticity determine the nature of the relationship between
2 goods?
○ The Cross Price elasticity of Demand is Positive for Substitute Goods
○ The Cross Price elasticity of Demand is Negative for Complementary Goods
What is meant by the Price Elasticity of Supply?
supply measures the responsiveness of quantity supplied to a change in price. The price elasticity of supply (PES) is measured by % change in Q.S divided by % change in price.
Why is the Price Elasticity of Supply positive in sign?
The positive sign reflects the fact that higher prices will act an incentive to supply more. Because the coefficient is greater than one, PES is elastic and the firm is responsive to changes in price. This will give it a competitive advantage over its rivals.
How does the shape of the Supply curve vary with the value of the Price elasticity of supply?
The supply curve is shallower (closer to horizontal) for products with more elastic supply and steeper (closer to vertical) for products with less elastic supply.
What is meant by the Consumer’s willingness to pay / Reservation price? How is it related to the Marginal utility?
The price a consumer is willing to pay for a good depends on its marginal utility, which declines with each additional unit of consumption, according to the law of diminishing marginal utility. Therefore, the price decreases for a normal good when consumption increases.
What does the Consumer surplus represent? How is it measured both mathematically and in
terms of graphs?
actual market price of the good.
Visually, it appears as a triangular area under the demand curve, extending from the equilibrium quantity to the maximum willingness-to-pay price
. What happens to the Consumer surplus when the market price increases/ decreases?
Consumer surplus is based on the economic theory of marginal utility, which is the additional satisfaction a consumer gains from one more unit of a good or service. Consumer surplus always increases as the price of a good falls and decreases as the price of a good rises
How do we measure the producer’s surplus? Both mathematically as well as graphically
producer surplus quantifies the extra benefit gained by producers when market prices surpass their minimum acceptable price. Graphically represented as the region above the supply curve and below the market price. Calculation involves subtracting the total production cost from total revenue, with marginal cost playing a pivotal role.
What happens to the value of the Producer surplus as market price changes in the market?
Changes in price are directly associated with the amount of surplus a producer will receive. Graphically, the producer surplus is directly above the supply curve, but below the price. Other things equal, as equilibrium price increases, the amount of potential producer surplus and the number of goods supplied increases.
Implicit Costs:
Implicit costs represent the opportunity cost of choosing one course of action over another.
These costs are not directly recorded in financial statements but are equally important.
Examples of implicit costs include:
Foregone Income: If an entrepreneur decides to start their own business, the implicit cost is the income they could have earned by working elsewhere.
Time and Effort: The time spent on a project or venture has an implicit cost because it could have been used for other activities.
Use of Personal Resources: If an individual uses their own equipment or property for business purposes, the value of that resource is an implicit cost.
Explicit Costs:
Explicit costs are the actual monetary payments made by a business or an individual for resources or services.
These costs are easily identifiable and can be recorded on financial statements.
Examples of explicit costs include:
Wages and Salaries: Payments to employees for their work.
Rent: The cost of leasing office space or equipment.
Raw Materials: The expenses incurred to purchase materials for production.
Utilities: Payments for electricity, water, and other services.
Advertising Expenses: Costs related to marketing and promotion.
Accounting Profit vs. Economic Profit:
Accounting Profit: Calculated by subtracting explicit costs (such as rent, wages, and materials) from total revenue. It focuses on the financial performance of a business.
Economic Profit: Takes into account both explicit and implicit costs. It subtracts all costs (including opportunity costs) from total revenue. If economic profit is positive, the venture is considered worthwhile; if negative, it suggests inefficiency.
Short-Run Production in Microeconomics
In the short run, at least one input (usually capital) is fixed. This means that certain resources cannot be easily adjusted.
Variable inputs (like labor) can be changed to increase or decrease production.
For example, a bakery may have a fixed-size oven (fixed input) but can hire more bakers (variable input) to produce more cakes.
Fixed Input in the Short Run:
A fixed input is a factor of production that cannot be readily changed during the short run.
Examples include factory space, specialized machinery, or long-term lease agreements.
Variable Input in the Short Run:
A variable input is a factor of production that can be adjusted during the short run.
Examples include labor (hiring or firing workers), raw materials, and energy usage.
Total Product, Average Product, and Marginal Product
Total Product (TP): The total output produced by a firm.
Average Product (AP): TP divided by the quantity of the variable input (e.g., labor). It indicates the average output per unit of input.
Marginal Product (MP): The additional output produced by adding one more unit of the variable input. It measures the rate of change in TP.
Increasing and Diminishing Marginal Product:
Increasing MP: Occurs when each additional unit of the variable input contributes more to TP than the previous unit. It reflects efficient resource utilization.
Diminishing MP: Beyond a certain point, adding more units of the variable input leads to diminishing returns. MP declines, indicating inefficiency.
Total Fixed Cost, Total Variable Cost, and Total Cost
Total Fixed Cost (TFC): Fixed costs that do not change with output (e.g., rent, insurance).
Total Variable Cost (TVC): Variable costs that vary with output (e.g., labor, raw materials).
Total Cost (TC): The sum of TFC and TVC.
Average Fixed/Variable/Total Cost
Average Fixed Cost (AFC): TFC divided by output. It decreases as output increases.
Average Variable Cost (AVC): TVC divided by output. It tends to exhibit a U-shaped curve.
Average Total Cost (ATC): TC divided by output. It also follows a U-shaped pattern.
Short-Run Relation Between Marginal and Average Costs
If MC < AVC, AVC decreases.
If MC > AVC, AVC increases.
When MC = AVC, AVC is at its minimum.
Minimum Point of Short-Run Average Cost Curve
The minimum point of the SRAC curve represents the most efficient level of production.
It occurs where MC equals ATC.
Shape of Long-Run Average Cost Curve
The LRAC curve is U-shaped due to economies and diseconomies of scale.
Economies of Scale: As output increases, costs per unit decrease due to factors like specialization and bulk purchasing.
Diseconomies of Scale: Beyond a certain point, costs per unit rise due to inefficiencies.
Perfectly Competitive Market Characteristics and Examples
Identical products.
Many buyers and sellers.
Price-takers.
Perfect information.
Easy entry/exit.
Examples: Agricultural industry (wheat, corn), stock market, retail sector (clothing, electronics
Why Is a Firm in a Competitive Market a Price-Taker?
In perfect competition, firms accept market price due to lack of market power.
They cannot influence prices; many competitors exist.
How Is the Price Decided for Competitive Firms?
Firms produce where marginal cost (MC) equals market price.
Charge this price for their output.
Calculation of Total Revenue (TR), Average Revenue (AR), and Marginal Revenue (MR)
TR: Price × Quantity Sold.
AR: TR divided by quantity.
MR: Change in TR from selling one more unit.
