WEEK 2|Micro-economic concepts: Flashcards
Utility: cardinal vs ordinal, indifference curves. Demand and supply curves, changes in demand and elasticity. production cost, cost curves. Make vs buy decisions, production quantity decisions
What is the principle assumption upon which the theory of consumer behaviour and demand is built upon?
“a consumer attempts to allocate his/her limited money income among available goods and services so as to maximize his/her utility (satisfaction).”
What is Utility?
Utility - amount of satisfaction derived from the consumption of a
commodity ….measurement units = utils
What is “The cardinal Utility Theory (TUC)”?
The Cardinal Utility Theory (TUC)
* Utility is measurable in a cardinal sense
* cardinal utility - assumes that we can assign values for utility.
E.g., derive 100 utils from eating a slice of bread
What is “The Ordinal Utility Theory (TUO)”?
- Utility is measurable in an ordinal sense
- ordinal utility approach - does not assign values, instead works with a ranking of preferences.
In “The Cardinal Approach”, What is Total Utility?
Total utility (TU) - the overall level of satisfaction derived from consuming a good or service
In “The Cardinal Approach”, What is Marginal Utility (MU)?
Marginal utility (MU) additional satisfaction that an individual derives from
consuming an additional unit of a good or service.
Formula :
MU = Change in total utility/Change in quantity
= ∆ TU/∆ Q
In “The Cardinal Approach” What does the law of Diminishing Marginal Utility(Return) mean?
- Law of Diminishing Marginal Utility (Return) = As more and
more of a good are consumed, the process of consumption
will (at some point) yield smaller and smaller additions to
utility - When the total utility maximum, marginal utility = 0
- When the total utility begins to decrease, the
marginal utility = negative (-ve)
What is Consumer Equilibrium?
Consumers face constraints (income and prices) - therefore if MUx/Px>MUy/Py, customer will spend more on Good X and less on Good Y
In “The Ordinal Approach”, What is the indifference curve?
- Axes: both axes refer to the quantity of goods.
- Curve where the points represent a combination of items when
the consumer at indifference situation (satisfaction).
Curve shifts to upward right for more satisfaction
Curve shifts to downward left for less satisfaction
What are the properties of indifference curve?
- Downward sloping from left to right
- Convex to the origin
- Do not cross (intersect)
- Different ICs show different level of satisfaction.
What is a market?
Market : A group of buyers and sellers of a particular good or service.
Buyers: Determine the demand for the product
Sellers: Determine the supply of the product
What is “Quantity Demanded”?
Amount of good that buyers are willing and able to purchase.
What is the law of demand?
Other things equal, when the price of the good rises, Quantity demanded of a good falls.
What is a Demand schedule?
A Table - Relationship between the price of a good and quantity demanded
What is a Demand Curve?
A Graph - Relationship between the price of a good and quantity demanded
What is individual demand?
Demand of one individual
What is Market demand curve?
Sum of individual demand curves horizontally
How are shifts in demand curve expressed?
- Increase in demand - demand curve shifts right - signifies any change that increases the quantity demanded at every price.
- Decrease in demand - Demand curve shifts left - signifies any change that decreases the quantity demanded at every price
What are the variables which shift the demand curve?
- Income
- Price of related goods
- Tastes
- Expectations
- Number of buyers
What are inferior goods?
How does demand vary with Income?
All other things constant, Increase in income will tend to increase quantity demanded and vice versa in case of normal goods. Whereas for inferior goods, the opposite.
What are substitute goods vs complement goods?
How does price of related products affect demand?
Substitute - two goods. An increase in price of one good increases the demand of the other good
Complements - Two Goods. An increase in price of one good will decrease the demand of the other good.
How does “Tastes” affect demand?
changes in tastes - changes the demand.
expectations of increased income, price increase - increases current demand.
How does no of buyers affect demand?
As the number of buyers increase , market demand increases.
What is equilibrium?
Equilibrium is a situation where demand and supply forces are in balance. market price is such that the quantity supplied = quantity demanded. The supply and demand curves intersect.
What is equilibrium price?
Balances quantity supplied and quantity demanded
Market clearing price
What is equilibrium quantity?
Quantity supplied and the quantity demanded at equilibrium price
What is surplus?
quantity supplied > quantity demanded
excess supply (surplus).
price goes down. demand increases supply decreases.
What is shortage?
Quantity demanded > quantity supplied
excess demand (shortage)
price goes up. demand decreases, supply increases.
What is the law of supply and demand?
The price of any good adjusts to bring the quantity supplied and the quantity demanded into balance. In most markets, surplus and shortage are temporary.
What is “Elasticity of demand”?
Measure of responsiveness of quantity demanded or quantity supplied, to a change in one of its determinants.
What is price elasticity of demand?
percent change in quantity demanded divided by percent change in price
What does “Elastic demand” mean?
Quantity demand responds substantially to changes in price.
price elasticity >1
What does “Inelastic demand” mean?
Quantity demanded responds only slightly to changes in price.
price elasticity <1
What are some of the determinants of price elasticity of demand?
- Availability of close substitutes
- Necessities Vs. Luxuries
What does Unit Elasticity mean?
price elasticity =1
What does “Perfectly elastic” mean?
price elasticity =0
What is the price elasticity of supply?
Percentage change in quantity supplied divided by percentage change in price
What is elastic supply?
Quantity supplied responds substantially to changes in the price
What is inelastic supply?
Quantity supplied responds only slightly to changes in the price.
What is the determinant of price elasticity of supply?
Time period - supply is more elastic in the long run
what are the varieties of supply curves?
- supply is unit elastic (price elasticity of supply =1)
- Supply is elastic (price elasticity of supply >1)
- Supply is inelastic (price elasticity of supply <1)
What is income effect?
Income effect is a change in consumer’s real puchasing power brought about by a change in the price of the good.
What is substitution effect?
Substitution effect is an incentive to increase consumption of a good whose price falls, at the expense of other, now relatively more expensive,goods.
What does income elasticity measure?
Shifts in demand curve
What does price elasticity measure?
movements along the curve
What does cross-price elasticity measure?
shifts in the demand curve
Normal Vs. Inferior Goods
Normal goods have a positive income elasticity
Inferior goods have a negative income elasticity
Necessities Vs Luxuries
Necessities typically have an income elasticity between 0 and 1
Luxuries typically have an income elasticity greater than 1
What are the types of costs?
- Opportunity costs and actual cost
- DIrect and indirect cost
- Explicit and implicit cost
- HIstorical and replacement cost
- FIxed cost and variable cost
- Real and prime cost
- Total, average and marginal cost
What is Opportunity cost?
Cost incurred for losing next best alternative
What is Actual cost?
An actual amount paid or incurred as opposed to estimated cost or standard cost
What is explicit cost?
Explicit cost refers to the money expended to buy or hire resources from outside the organization for process of production.
What are implicit cost?
Implicit cost refers to the cost of use of the self owned resources of organization that are used in production.
What are direct cost?
Direct costss are those cost that have directly accountable to specific cost object such as a process or product. Ex: Wages paid, Salary Paid Labor, Material etc
What are indirect cost?
Indirect cost are those costs which are not directly accountable to specific cost object or not directly related to production. Eg: Insurance, maintainence, telecom etc.
What is historical cost?
Orginal(actual) cost incurred at the time the asset was acquired
What is replacement cost?
price that an entity would pay to replace an existing assets at current market price that may not be market value of that asset.
What is fixed cost?
cost that remains unchanged irrespective of the output level or sales revenue such as interest rent salaries etc.
what is variable cost?
costs that vary depending on a company’s production volume; they raise as production increases and fall as production decreases.
what is real cost?
physical quantities of various factors used in producing commodity. Ex: Real cost of a table composes of a carpenter’s labor to cubic feet of a wood, a dozen of nails, half a bottle of varnish, etc., Real cost thus signifies the aggregate of real productive resources absorbed in the production.
What is prime cost?
The direct cost of commodity in terms of the materials and labor involved in its prodcution excluding fixed cost. By calculating prime cost the firm can decide now much should be their selling price to earn profit.
What is production function?
defines the relationship between inputs and the maximum amount that can be produced within a given period of time witha a given level of technology
What is short-run production function?
The maximum quantity of output that can be produced by a set of inputs. Assumption: the mount of atleast oen of the inputs used remains unchanged
What is long-run production function?
The maximum quantity of output that can be produced by a set of inputs. Assumptions: the firm is free to vary the amount of all the inputs being used.
