Reading 12: Topics in Demand and Supply Analysis Flashcards
Describe the relationships between average and marginal cost curves.
MC intersects ATC and AVC from below at their respective minimum points.
When MC is below AVC (ATC), AVC (ATC) falls, and when MC is above AVC (ATC), AVC (ATC) rises.
Define income elasticity.
EDI=%ΔQDx/%ΔI
Income elasticity of demand measures the responsiveness of demand to a change in income, holding all other things constant.
Describe marginal cost (MC).
MC=ΔTC/ΔTP
For the same FC level:
MC=ΔTVC/ΔTP
What is the optimal output level for a plant?
When its ATC curve is at its minimum. The long-run average cost (LRAC) curve illustrates the relationship between the lowest attainable average total cost and output when all factors of production are variable.
Describe how the total expenditure (revenue) test gauges price elasticity.
Relatively elastic: Price cut increases revenue.
Relatively inelastic: Price cut decreases revenue.
Unit elastic: Price cut does not change total revenue.
Explain the law of demand.
The law of demand states that as the price of a product increases (decreases), consumers will be willing and able to purchase less (more) of it (i.e., price and quantity demanded are inversely related).
Note: The downward-sloping demand curve illustrates the law of demand (i.e., quantity demanded increases as price decreases).
Explain how the cost of producing a given level of output can fall.
If there is a decline in the cost of inputs, and/or an increase in input productivity. An improvement in labor productivity occurs when, given a fixed amount of capital, fewer units of labor are required to produce the same output.
Describe characteristics of income elasticity, when less than zero (negative), between 0 and 1, and greater than 1.
Negative:
Negative change in demand; Classified as an inferior good
Consumer spends less on the good overall/as a proportion of income
Between 0 and 1:
Percentage increase in demand is less than percentage increase in income
Consumer spends lower proportion of income on product
Classified as a normal good
Greater than 1:
Percentage increase in demand exceeds percentage change in income
Consumer spends higher proportion of income on product
Classified as income elastic and as a normal good
Give the equation to determine accounting profit (i.e., net profit) and economic profit. In addition, differentiate between accounting and economic depreciation.
Accounting profit/(loss) = Total revenue – Total accounting costs
Economic profit = Revenue less all economic costs, such as opportunity costs and ignoring sunk costs
Economic depreciation is forward looking, while accounting depreciation is backward looking. While both are useful—one for making operating decisions and the other for reporting and tax purposes—there isn’t necessarily a direct link between the two.
Describe what happens to elasticity along a linear demand curve.
On a downward sloping demand curve and left of unit elasticity, changes in price result in relatively larger changes in QD (elastic). Right of unit elasticity, changes in price result in relatively smaller changes in QD (inelastic).
Note: |EDPx|=1:Unit elastic |EDPx|=0:Perfectly inelastic |EDPx|=∞:Perfectly elastic 01:Relatively elastic
Differentiate between a nondiscretionary good and a discretionary good.
Nondiscretionary: Necessary and less elastic.
Discretionary: Optional and more elastic.
Define perfect and imperfect competition.
With perfect competition, each individual firm faces a perfectly elastic demand curve. Firm output decisions have no impact on market price. The firm is referred to as a price taker.
With imperfect competition, the firm output decisions can affect price, but a downward sloping demand curve requires a price decrease to increase output. Firms are referred to as price-searchers.
How do the substitution effect and the income effect impact normal and inferior goods?
With a normal good, a decrease in price causes consumers to buy more of this good in place of other goods (substitution effect). The increase in real income resulting from the decline in this good’s price causes people to buy even more of this good (income effect).
With an inferior good, the substitution effect of a change in price will be the same as for a normal good. However, the increase in real income resulting from the decline in this good’s price will be spent on more desired goods.
Distinguish among average total cost (ATC), average fix cost (AFC), and average variable cost (AVC).
Average total cost (ATC) equals total cost (TC) divided by total product (TP).
Average fixed cost (AFC) equals TFC divided by TP.
Average variable cost (AVC) equals TVC divided by TP.
Explain the breakeven point and shutdown decision.
Breakeven is where a firm covers all of its economic costs (total accounting costs and implicit opportunity costs) but 0 economic profit.
TR = TC: Operate (SR and LR)
TR = TVC but < TC: Operate (SR), exit (LR)
TR < TVC: Shut down (SR and LR)
