1. Chapter 4: Elasticity Elasticity of Demand:
It measures the responsiveness of quantity demanded (or demand) with respect to changes in its own price (or income or the price of some other commodity).

2. Why is Elasticity Important?
How does a firm go about determining the price at which they should sell their product in order to maximize total revenue?
Total Revenue = Price ´ Quantity

3. You are a marketing manager for Intel
A new computer chip has been developed
Decision to Be Made
Do you sell the new chip at a high price ($400)?
Do you sell the new chip at a low price ($200)?

4. Demand and Total Revenue
400
Price (dollars per chip)
300
200 Da
100
Quantity (millions of chips per year)

5. Demand and Total Revenue
400
Price (dollars per chip)
300
200
100 Db
Quantity (millions of chips per year)

6. Demand and Total Revenue
Price (dollars per chip)
Price (dollars per chip) Da Db
Quantity (millions of chips per year)
Quantity (millions of chips per year)

7. Slope Depends on Units of Measurement
In these two examples, we can compare the slopes of the demand curves
We cannot do so if we are dealing with different goods and services. Or whenever the unit of measurement has been changed.

8. Effect of a change of unit of measurement on Slope
Price 10 9 8 7 6 5 4 3 2 1 1 2 3 4 5 6 7 8 9 10 11 12
Quantity

9. Slope Depends on Units of Measurement
In these two examples, we can compare the slopes of the demand curves
We cannot do so if we are dealing with different goods and services. Or, whenever the unit of measurement has been changed.
Elasticity is independent of the units of measurement.

10. Price elasticity of demand
A measure of the responsiveness of the quantity demanded of a good to a change in its own price (ceteris paribus).

11. Elasticity: A Units-Free Measure
Price Elasticity of Demand

12. Calculating Elasticity
The changes in price and quantity are expressed as percentages of the average price and average quantity.
This way we avoid having two values for the price elasticity of demand for the same range of the demand curve

13. Example: Suppose, quantity demanded changes from 150 to 100 when Price increases from 5 to 10 dollars. Find out the price elasticity of demand for this specific range of the demand curve.

14. Calculating the Elasticity of Demand
Original
point
410
Price (dollars per chip)
390 Da
Quantity (millions of chips per year)

15. Calculating the Elasticity of Demand
Original
point
410
Price (dollars per chip)
New
point
390 Da
Quantity (millions of chips per year)

16. Calculating the Elasticity of Demand
Original
point
410
Price (dollars per chip)
= -$20
New
point
390 Da
= 8
Quantity (millions of chips per year)

17. Price (dollars per chip)
Original
point
410
Price (dollars per chip)
= -$20
400
Pave = $400
New
point
390 Da
= 8
Quantity (millions of chips per year)

18. Calculating the Elasticity of Demand
Original
point
410
Price (dollars per chip)
= -$20
400
Pave =$400
New
point
Qave = 40
390 Da
= 8
Quantity (millions of chips per year)

19. Calculating Elasticity
= - 4

20. Inelastic and Elastic Demand
Three demand curves that cover the entire range of possible elasticities of demand:
Perfectly inelastic
Unit elastic
Perfectly elastic

21. Perfectly inelastic demand
Implies that quantity demanded remains constant when price changes occur.
Price elasticity of demand = 0

22. Price D
Elasticity = 0 12
Perfectly Inelastic 6 1
Quantity

23. Unit elastic demand
Implies that the percentage change in quantity demanded equals the percentage change in price.
Price elasticity of demand = -1

24. Unit Elastic Demand Price Elasticity = -1 12 Unit Elasticity 6 D 1 2 3
Quantity

25. Perfectly elastic demand
Implies that if price increases by any percentage, quantity demanded will fall to 0 and if price decreases by any percentage, quantity will rise to infinity.
Price elasticity of demand =

26. Perfectly Elastic Demand
Price
Elasticity = 12 D3 6
Perfectly Elastic
Quantity

27. Inelastic and Elastic Demand
Inelastic demand
Implies the percentage change in quantity demanded is less than the percentage change in price.
In absolute sense, price elasticity of demand > 0 and < 1
Elastic demand
Implies the percentage change in quantity demanded is greater than the percentage change in price.
In absolute sense, price elasticity of demand > 1

28. Elasticity Along a Straight-Line Demand Curve
500
Price (dollars per chip)
400
300
250
200
100
Quantity (millions of chips per year)

29. Elasticity Along a Straight-Line Demand Curve
500
Lowering the price
from $500 to $300
results in a price
elasticity of demand of -4.
Elastic
Price (dollars per chip)
400
300
250
200
100
Quantity (millions of chips per year)

30. Elasticity Along a Straight-Line Demand Curve
500
Lowering the price
from $200 to $0
results in a price
elasticity of demand of -1/ 4.
Price (dollars per chip)
400
Inelastic
300
250
200
Elasticity = -1/4
100
Quantity (millions of chips per year)

31. Elasticity Along a Straight-Line Demand Curve
500
Lowering the price
from $500 to $0
results in a price
elasticity of demand of -1.
|Elasticity| > 1
Price (dollars per chip)
400
|Elasticity| = 1
300
250
200
|Elasticity| < 1
100
Quantity (millions of chips per year)

32. Elasticity, Total Revenue and Expenditure
TR = P x Q
Elasticity, Total Revenue and Expenditure
Elastic demand — a 1 percent decrease in price will result in a greater than 1 percent increase in quantity demanded.
Total revenue will increase
Unit elastic demand — a 1 percent decrease in price will result in a 1 percent increase in quantity demanded
Total revenue will not change

33. Elasticity, Total Revenue and Expenditure
Inelastic demand — a 1 percent decrease in price will result in a less than 1 percent increase in quantity demanded.
Total revenue will decrease

34. Elasticity, Total Revenue and Expenditure
Total Revenue Test
Price elasticity of demand can be estimated by observing the change in total revenue that results from a price change (ceteris paribus).

35. Elasticity, Total Revenue & Expenditure
Total Revenue Test
Price cut and total revenue increases
demand is elastic.
Price cut and total revenue decreases
demand is inelastic
Price cut and total revenue does not change
demand is unit elastic

36. 500
Price (dollars per chip)
400
300
250
200
100 D
TR = P x Q

37. 500
Price (dollars per chip)
400
300
250
200
100 D 25 20
Total Revenue (billions of dollars) 15 10 TR 5
Quantity (millions of chips per year)

38. Elastic
demand
500
Price (dollars per chip)
400
Unit
elastic
300
250
200
Inelastic
demand
100 25
Maximum
total revenue 20
Total Revenue (billions of dollars) 15
When demand
is inelastic,
price cut decreases
total revenue
When demand
is elastic,
price cut
increases
total revenue 10 5
Quantity (millions of chips per year)

39. More Elasticities of Demand
Cross elasticity of demand
Measures the responsiveness of the demand for a good to a change in the price of a substitute or complement good.
Cross elasticity
of demand =
Percentage change in Demand
Percentage change in price of
a substitute or complement

40. Income Elasticity of Demand
Measures the responsiveness of the demand to a change in income.
Income elasticity
of demand =
Percentage change In Demand
Percentage change in income

41. Income Elasticity of Demand
Income elasticity can be:
1) Greater than 1 (normal good, income elastic)
luxury goods - ocean cruises, jewelry
2) Between zero and 1 (normal good, income inelastic)
necessities - food, clothing
3) Less than zero (inferior good)
potatoes, rice

42. Unit Tax and Tax Burden:
Price 10 S2 9 S1 8 7 6 5 $2 4 3 2 1 1 2 3 4 5 6 7 8 9 10 11
Quantity

43. Unit Tax and Tax Burden:
Price 10 S2
Consumers’ part 9 S1 8 7 6 $2 5 4 3 2 1
Suppliers’ part 1 2 3 4 5 6 7 8 9 10 11
Quantity

44. Elasticity and Tax Burden: Perfectly Inelastic Demand
Price 10 S2
Consumers’ part 9 S1 8 7 6 $2 5 4 3 2 1 1 2 3 4 5 6 7 8 9 10 11
Quantity

45. Elasticity and Tax Burden: Perfectly Elastic Demand
Price 10 S2 9
Producers’ part S1 8 7 6 5 4 $2 3 2 1 1 2 3 4 5 6 7 8 9 10 11
Quantity

46. Elasticity and Tax Burden: Perfectly Elastic Supply
Price 10
Consumers’ part 9 8 7 6 S2 $2 5 S1 4 3 2 1 1 2 3 4 5 6 7 8 9 10 11
Quantity

47. Elasticity and Tax Burden: Perfectly inelastic Supply
Price S1 10 9
Producers’ part 8 7 6 5 4 3 $2 2 1 1 2 3 4 5 6 7 8 9 10 11
Quantity

48. Chapter 5
Marginal Utility & Consumer Choice:

49. Utility:
The satisfaction or enjoyment a person obtains from consuming a good.
Util:
A hypothetical unit used to measure how much utility a person obtains from consuming a good.

50. Marginal Utility: Total Utility:
The change in total utility a person derives from consuming an additional unit of a good.
Total Utility:
The total number of utils a person derives from consuming a specific quantity of a good.

51. Law of Diminishing Marginal Utility:
The idea that as more of a good is consumed, the utility a person derives from each additional unit diminishes.

52. Total and Marginal Utility

53. Water-Diamond Paradox:
How much people value a good depends upon the utils they derive from the last unit consumed or the Marginal Utility.

54. Making selection from a given budget:

55. Making selection from a given budget:

56. 20% Sale on Clothing:

57. MU/P Equalization Principle:

58. Consumer Surplus:
The difference between the maximum amount a person would be willing to pay for a good or service and the amount the person actually pays.

59. Price 10 8 6 3 D 1 2 3
Quantity

60. Price 3 D
Quantity

61. Chapter 6:
Price Ceilings and Price Floors

62. Civilian Goods
Defense Goods

63. S2
Price ($) S1 10
Price Ceiling 4 D 7 10
Quantity (1,000)

64. S2
Price ($) 10
Price Ceiling 4 D 4 7 10
Excess Demand or Shortage
Quantity (1,000)

65. Price ($) S1
Excess Supply or Surplus S2
Price Floor 4 2 D 10 12 14
Quantity (1,000)

66. Price ($)
Excess Supply or Surplus S2
Price Floor 4 2 D 10 12 14
Quantity (1,000)

67. Chapter 8
Costs of Production

68. What is a Fixed Cost?
Cost to a firm that does not vary with the quantity of goods produced

69. What are examples of Fixed Costs?
rent or mortgage
a part of utilities

70. Fixed Costs are also known as…..
Sunk Cost

71. What is a Variable Cost?
Cost that varies with the quantity of goods produced

72. What are examples of Variable Costs?
worker’s wages
raw materials
some utilities
some taxes

73. What is Labor Productivity?
The output per laborer per hour

74. Under what condition is it cheaper to pay $10 an hr. to a U. S
Under what condition is it cheaper to pay $10 an hr. to a U.S. worker than $1 an hour to a foreign worker?

75. If the U.S. worker is more than 10 times as productive as the foreign worker

76. Why do labor costs per unit of output changes as more units of labor are hired?
Price of labor increases
Quality of labor decreases
Labor productivity Changes

77. Why do non-labor, variable costs per unit of output increase as output increases?
Resources become more scarce

78. Does the cost of all resources increase more than production increases?
No, the costs of some resources may vary proportionately with the level of production

79. What is Total Variable Cost?
The sum of specific variable costs in the firm’s cost structure

80. Total Variable Costs $ Q

81. What are Total Costs?
Cost to the firm that includes both fixed and variable costs

82. Total Costs TC $
TVC
TFC Q

83. What is Average Total Cost?
Total cost divided by the quantity of goods produced

84. $ TC
TVC 10
ATC = 9
5/2 = 2.5 8 7 6 5
ATC = 4
6/5 = 1.2 3 6 5 2 1 Q 1 2 3 4 5 6 7 8 9 10

85. $ 10 9 8 7
ATC 6 5 4 3 2 1 Q 1 2 3 4 5 6 7 8 9 10

86. What is Average Variable Cost?
Total variable cost divided by the quantity of goods produced

87. $ 10 9
TVC 8 7 6 5 4 3 2 1 Q 1 2 3 4 5 6 7 8 9 10

88. $ 10 9 8 7
ATC 6 5
AVC 4 3 2 1 Q 1 2 3 4 5 6 7 8 9 10

89. What is Average Fixed Cost?
Total fixed cost divided by the quantity of goods produced

90. Costs
AFC
Quantity
9090

91. What is Marginal Cost?
The change in total cost associated with one more unit of production

92. If the only thing we observe is a change in total cost associated with a small change in output produced then MC is computed in the following way.
MC = Q TC

93. $ TC 10
MC = 9
3/3 = 1 8 3 7 6 5 3 4 3 2 1 Q 1 2 3 4 5 6 7 8 9 10

94. $ TC 10 9 8 7 6 5 4 3 2 1 Q 1 2 3 4 5 6 7 8 9 10

95. TC,
TVC,
TFC
TFC Q1 Q2 Q3 Q MC
ATC
AVC
AFC Q

96. $ 10 MC 9
ATC 8 7
AVC 6 5 4 3 2 1 Q 1 2 3 4 5 6 7 8 9 10

97. $ 10 MC 9
ATC 8 7
AVC 6 5 4 3 2 1 Q 1 2 3 4 5 6 7 8 9 10

98. What is the Short Run?
A time period in which producers can change some, but not all of its resources
What is the Long Run?
The time period in which producers can change quantities of all resources

99. Short-run Vs. Long-run Average Cost
$ per unit of Output
SRACD
SRACC
SRACA
SRACB
LRAC Q1 Q2 Q3 Q

100. What are Economies of Scale?
When a firm increases resources in the long run and ATC decreases
What are Diseconomies of Scale?
When a company increases resources in the long run and ATC increases