Microeconomics Quiz 3 Notes PDF

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I.

II.

III.

Price Discrimination - the practice of charging different customers different prices for the same good/service → possible because different customers have different sensitivities to price changes → measured by elasticity of demand A. Different flight tickets (still going from point A to point B) (economy, first, business) B. Electricity and phone - charges more during the day (business operate in the day) C. Apply can charge high prices because they know people will still buy it Price Elasticity of Demand (Ed) - absolute value of the percentage change in quantity demanded divided by the percentage change in prices A. Ed = |percentage change in quantity/percentage change in price| = |%△Q/%△P| = |(△Qd /QA )/(△P/Pa )| = |[(Q2-Q1)/[(Q2+Q1)/2]]/[(P2-P1)/[(P2+P1)/2]]| = |(△Q/△P)*(PA/QA)| = |(1/slope)*(PA/QA)| B. Slope=△P/△Q C. Even when slope is constant, elasticity of demand is different (demand is always positive) D. Elastic (sensitive) - given percent change in price results to more than proportionate percentage change in quantity; Ed > 1 1. Elasticity is 6, want to increase rev → music CDs → decrease price, quantity increase a lot E. Unitary-elastic - given percentage change in price results to exactly the same percentage change in quantity; Ed = 1 F. Inelastic (not sensitive) - given percentage change in price results to less than proportionate percentage change in quantity; Ed < 1 1. Elasticity is ⅙, want increase rev → increase price, quantity will only fall a little (smokers are still gonna smoke) → More revenue 2. Bumper Harvest Paradox (Coffee) 3. Minimum Wage → as min wage increase → becomes more elastic G. Perfectly inelastic - vertical line (even if price increase for knee replacement, people still gonna do it; mostly health) H. Perfectly elastic - horizontal line I. Factors 1. Luxury Goods (goods we can live without but make us happier) vs. Necessities (goods can’t live without) a) Luxury - elastic b) Necessity - inelastic 2. Close substitutes - elastic a) Same price for halal → one raises price → we switch immediately 3. Share of Budget (house → big share; book → small share) a) Bigger the share of the good → more elastic b) Smaller → inelastic 4. Time a) When time passes → more elastic b) If gas increase by $1 → maybe I won’t drive everyday → carpool? 5. Market equilibrium for coffee a) Demand is inelastic (not perfectly); Standard supply; mark the revenue Utility - satisfaction; scientific concept using economics to describe how rational consumers divide their resources across goods and services that bring them satisfaction A. Non-satiated preferences - the more the better B. Transitive preferences - like A more than B, like B more than C therefore like A more than C C. Complete preferences - rational consumers at any point in time, preferences are complete (they know what they want) D. Utility Theory (Cardinal vs. Ordinal; Total vs. Marginal) 1. Cardinal - utility levels; measure satisfaction 2. Ordinal - don’t know what levels of satisfaction but can rank options 3. Total - total satisfaction that consumers get from consuming a given good/service a) Sum of all units 4. Marginal (addition) - the additional utility/satisfaction that we receive from consuming one more unit of a good/service, all else equals a) Can be negative

IV.

E. The Law of Diminishing Marginal Utility* - at least after some point, each additional unit of a good/service will bring consumers less and less additional satisfaction, all else equals 1. The prices that we are willing to pay for goods/service reflects marginal utility (not total) 2. Adam Smith a) wealth of nations → how come the prices of goods that are vital are so low while the prices of goods that seem useless are so high (1) Prices reflect marginal and not total satisfaction b) Specialization, laissez faire, invisible hand 3. Cash is the best gift → matches our preferences perfectly 4. Consumer surplus - difference between how much consumers are willing to pay vs. how much they actually pay 5. Producer surplus - difference between how much suppliers are willing to sell for vs. what they actually get 6. CS + PS = Welfare → government want to maximize the happiness of consumer and producer Business Organization A. Types 1. Firms/companies - specialized organizations devoted to production and supply of goods and services 2. Individual Proprietorships - owned individually 3. Partnership - joint ventures by 2 or more people 4. Corporations - business organization/company that is chartered (recognized) as a “legal person” by one of the 50 states or abroad, owned by shareholders/stockholders who have contributed money, time, ideas or other resources in return for stocks a) Downside - taxation (1) federal tax 35-40% of profits (2) State tax (3) Income tax 5. Hybrid Individual Proprietorships

Partnerships

Corporations

Scale

small

medium

large

# of Firms

72%

8%

20%

Sales

5%

10%

85%

Liability

unlimited

unlimited

limited

Ownership

individual

Several individuals

shareholders

Control

owner

owners

board of directors

B. Liability - what happens to assets when company declares bankruptcy 1. Unlimited - bank can take your house, car 2. Limited - corporation is a “legal person” → banks don’t go after owners (they are shareholders) → to company C. Production Function - the maximum amount of output that can be produced by a firm with a given amount of input, given level of technology and given period of time 1. Inputs (L, T, K) → output (total product; marginal product; average product) (technology) 2. Production Relationships a) Total product (Q): total quantity of output b) Marginal product (MP): increase in total product as a result of adding one more unit of input (=△Q/△I)

V.

Q

(1) Law of diminishing marginal productivity/returns - if we increase one input, all else equals, at least after some point each additional unit of this input will add less and less additional output c) Average product (AP): average produced by every worker of an input (=Q/I) D. Returns to Scale 1. Constant returns to scale (CRS) - double all inputs, output exactly doubles 2. Increasing returns to scale (IRS) - double all inputs, output increases more than double 3. Decreasing returns to scale (DRS) - double all inputs, output increases less than double E. Time and Production 1. Short run - period of time in which the firms can only change some of the inputs that they use 2. Long run - firms can change all inputs F. Technology and Production 1. Production innovation - come up with new products 2. Process innovation - situation in which we improve existing products 3. Technological regress - very rare situation when new technology is lost → goes backward Economic Costs A. Economics vs. Accounting costs 1. Economic costs concerns with efficiency + opportunity cost whereas accounting costs is only the total revenue - total cost 2. EC = AC + OC (opportunity cost) B. Economics vs. Accounting profits 1. EP = AP - OC C. Total Cost - total spending that a company has to pay for inputs to produce a given level of outputs a) Increasing, beginning stage increasing at decreasing rate and then at some point increasing at increasing rate b) Starts above 0 at the FC, always positive c) Slope of TC is MC 2. Fixed cost - costs that don't change with output (also known as sunk/overhead) a) Start at y axis, Y intercept above 0, horizontal line (constant) 3. Variable cost - vary directly with output (more produced, higher variable cost) a) Starts at 0 b) Parallel to total cost but below it D. Marginal Cost - additional cost for one more unit of output, all else equals a) Start above 0 close to y axis not touching it (to have marginal cost we need to start above 0) b) First decreasing then at some point increases (positive but decreasing slope; positive but increasing slope) c) Slope (derivative) of TC d) Intersects AC and AVC at its minimum e) Upward sloping because MP is falling (specialization cheaper to produce but LDMP more expensive to produce) 2. Average Cost - cost per unit a) U shaped, positive, starts at infinity (because of fixed cost) b) Pulls average down when MC is below AC c) Pulls average up when MC is above AC 3. Average Fixed Cost - fixed cost per unit a) Approaches 0 b) Always positive 4. Average Variable Cost a) Starts above 0 at MC, but doesn’t touch y b) Decreases to MC then increases approaching AC but doesn’t touch because of AFC = AC - AVC Fixed Costs (FC)

Variable Cost (VC)

Total Cost Marginal (TC=FC+VC Cost (MC= ) (△TC/△Q)

Average Cost (AC=TC/Q)

Average Fixed Cost (AFC=FC/Q

Average Variable Cost

=△TC= △VC)

)

(AVC=(VC/ Q)=)

0

55

0

55

--

∞

∞

--

1

55

30

85

30

85

55

30

2

55

55

110

25

55

27.5

27.5

3

55

75

130

20

43.3333

18.3333

25

4

55

105

160

30

40

13.75

26.25

5

55

155

210

50

42

11

31

6

55

225

280

70

46.6666

9 1/6

37.5

7

55

315

370

90

52 6/7

7 6/7

45

8

55

425

480

110

60

6.875

53.125...