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Chapter 6- Elasticity: The Responsiveness of Demand and Supply

Price elasticity of demand: the responsiveness of the quantity demanded to


a change in price. % change in quantity demanded/ % change in price. It is
always negative. Economists typically study the absolute value of price
elasticity of demand. Midpoint formula is used.
Summary of price elasticity of demand: If demand is elastic, then the
absolute value of price elasticity is greater than 1. If demand is inelastic, the
absolute value of price elasticity is between 0 and 1. If demand is unit elastic,
the absolute value of price elasticity is equal to 1. If demand is perfectly
elastic, the absolute value of price elasticity is infinity. If demand is perfectly
inelastic, the absolute value of price elasticity is equal to 0.
Determinants of the price elasticity of demand: Availability of close
substitutes, passage of time, luxuries vs necessities, definition of the market,
and share of the good in the consumers market.
Availability of close substitutes: the most important determinant. If a
product has more substitutes, it will have more elastic demand (price of
pizza rising). If a product has fewer substitutes, it will be have less elastic
demand (price of gasoline).
Passage of time: the more time that passes, the most elastic the demand for
a product becomes. Consumers dont adjust to higher gas prices after a week.
Luxuries vs Necessities: the demand for a luxury is more elastic than the
demand for a necessity. Demand for bread is inelastic (bread is necessity).
Demand for concert tickets is elastic (concert tickets are a luxury).
Definition of the Market: In a narrow market, there are more substitutes
available. The more narrowly we define a market, the more elastic demand
will be. (If we define a market to Shell gasoline, there will be more available
substitutes. If we define a market to gasoline, there will be less available
substitutes. The market for Shell is more elastic than the market for
gasoline.)
Share of a Good in a Consumers Budget: the demand for a good will be
more elastic the larger the share of the good in the average consumers
budget. Sugar versus a new car. Sugar has more inelastic demand than new
cars.
Elastic demand: when the price elasticity of demand > 1 in absolute value
Inelastic demand: when the price elasticity of demand is >0 but <1 in
absolute value
Cross price elasticity of demand: % change in quantity demanded of one
good/ % change in price of another good. If products are substitutes, then
CPED will be positive (two brands of tablet computers). If products are
complements, then CPED will be negative (tablet computers and apps). If
products are unrelated, then CPED will be zero (tablet computers and peanut
butter).
Income elasticity of demand: % change in quantity demanded/ % change
in income. If IED is positive but less than 1, then the good is normal and a
necessity (bread). If IED positive and greater than 1, then the good is normal

and a luxury (lobster). If IED is negative, then the good is inferior (instant
ramen noodles).
Price elasticity of supply: the responsiveness of the quantity supplied to a
change in price. % change in quantity supplied/ % change in price. Always
positive.
Determinants of the Price Elasticity of Supply: Depends on the ability and
willingness of firms to alter the quantity they produce as the price changes.
The supply curve will be inelastic if measured over a short period of time.
The supply curve will be elastic the longer the period of time over which we
measure it. Firms have difficult increasing the quantity they supply during
any short period of time. If supply is elastic, then the value of price elasticity
is greater than 1. If supply is inelastic, then the value of price elasticity is less
than 1. If supply is unit elastic, then the value of price elasticity is equal to 1.
If supply is perfectly elastic, then the value of price elasticity is infinite. If
supply is perfectly inelastic, then the value of price elasticity is equal to 0.
Chapter 10- Consumer Choice and Behavior Economics
Utility: The enjoyment or satisfaction people receive from consuming goods
and services. The higher the utility, the happier you are.
Marginal Utility: the chance in total utility a person receives from
consuming one additional unity of a good or service.
Law of Diminishing Marginal Utility: Consumers experience diminishing
additional satisfaction as they consume more of a good or service during a
given period of time.
Rational Behavior: Economic theory assumes that consumers behave
rationally. Rational consumers maximize their utility given their budget
constraint. In the real world, not all consumers behavior rationally.
Behavioral Economics: the study of situations in which people make
choices that do not appear to be economically rational. Three irrational
mistakes: consumers take into account monetary costs but ignore
nonmonetary opportunity costs, consumers fail to ignore sunk costs,
consumers are unrealistic about their future behavior.
Endowment effect: the tendency of people to be unwilling to sell a good
they already own even if they are offered a price that is greater than the price
they would be willing to pay the good if they didnt already own it. It implies
that peoples willingness to pay irrationally increases once they obtain the
item.
Sunk Cost: a cost that has already been paid and cannot be recovered.
Chapter 11- Technology, Production, and Costs
Labor: workers
Physical capital: factory/stores and machines
Short Run: the period of time during which at least one of a firms inputs is
fixed.
Long Run: the period of time in which a firm can vary all of its inputs, adopt
new technology, and increase or decrease the size of its physical plant.
Total Cost: The costs of all the inputs a firm uses in production.

Fixed Cost: Costs that remain constant as output changes.


Variable Cost: Costs that change as output changes
Production Function: The relationship between the inputs employed by a
firm and the maximum output it can produce with those inputs
Marginal Product of Labor: The additional output a firm produces as a
result of hiring one more worker
Law of Diminishing Returns: The principle that, as some point, adding
more of a variable input, such as labor, to the same amount of a fixed input,
such as capital, will cause the marginal product of the variable input to
decline.
Average Product of Labor: The total output produced by a firm divided by
the quantity of workers.
Marginal Cost: The change in a firms total cost from producing one more
unit of a good or service
Average Total Cost: Total cost divided by the quantity of output produced.
TC/Q
Average Fixed Cost: FC/Q
Average Variable Cost: VC/Q
Minimum efficient scale: the smallest quantity amount that minimizes Long
run Average Cost.
Increasing Returns to Scale: Both workers and management can become
more specialized, enabling them to become more productive, as quantity
increases.
Constant Returns to Scale: Minimum efficient scale is usually a quantity
amount associated with CRS.
Decreasing Returns to Scale: As quantity become overwhelmingly large,
managers have difficulty coordinating the operation of a store.