MIDTERMS REVIEWER IN ECONOMICS
CHAPTER 5: ELASTICITY
–Percentage change in quantity demanded
divided by percentage change in price
–Use absolute value (drop the minus sign)
Elasticity

–Measure of the responsiveness of quantity
demanded or quantity supplied
Two points: (Q1, P1) and (Q2, P2)

To a change in one of its determinants.
o Sensitivity of one market
variable to another
 Slope = ΔP/ΔQD
Midpoint method
Variety of demand curves
–Demand is elastic

Price elasticity of demand > 1
Not a measure of price sensitivity of demand
–Demand is inelastic
Depends on the arbitrary units of
measurement

Doesn’t tell us the significance of ΔP or ΔQD




Price elasticity of demand
Price elasticity of supply
Income elasticity of demand
Cross-price elasticity of demand
Price elasticity of demand < 1
–Demand has unit elasticity
Price elasticity of demand = 1
–Demand is perfectly inelastic


Price elasticity of demand = 0
Demand curve is vertical
Price Elasticity of Demand
–Demand is perfectly elastic
–How much the quantity demanded of a good
responds to a change in the price of that good


–Percentage change in quantity demanded
divided by the percentage change in price
The flatter the demand curve
Elastic demand
–Quantity demanded responds substantially to
changes in price
Inelastic demand
–Quantity demanded responds only slightly to
changes in price
Computing the price elasticity of demand
Price elasticity of demand = infinity
Demand curve is horizontal
–The greater the price elasticity of demand
CHAPTER 6: SUPPLY DEMAND AND
GOVERNMENT POLICIES
Price controls –Policymakers believe that
the market price of a good or service is unfair
to buyers or sellers
–Can generate inequities
Price ceiling
Government uses taxes
–A legal maximum on the price at which a good
can be sold
–To raise revenue for public projects
–Rent-control laws

Roads, schools, and national defense
Price floor
Tax incidence
–A legal minimum on the price at which a good
can be sold
–Manner in which the burden of a tax is shared
among participants in a market
–Minimum wage laws
How taxes on sellers affect market outcomes
How price ceilings affect market outcomes
–Taxes discourage market activity
–Not binding
–Buyers and sellers share the burden of tax


Set above the equilibrium price
No effect on the price or quantity sold
–Binding constraint



Set below the equilibrium price: Shortage
Sellers must ration the scarce goods
Rationing mechanisms: long lines,
discrimination according to sellers bias
How price floors affect market outcomes
–Not binding



–Sellers receive less, are worse off


Set above the equilibrium price: Surplus
Some sellers are unable to sell what they
want
Rationing mechanisms: not desirable
Taxes
Get the higher price but pay the tax
Overall: effective price fall
How taxes on buyers affect market outcomes
–Buyers and sellers share the burden of tax
–Sellers get a lower price, are worse off
–Buyers pay a lower market price, are worse off

Set below the equilibrium price
No effect on the market
–Binding constraint


–Buyers pay more, are worse off
Effective price (with tax) rises
Taxes levied on sellers and taxes levied on
buyers are equivalent
–Wedge between the price that buyers pay and
the price that sellers receive

The same, regardless of whether the tax is
levied on buyers or sellers
–Shifts the relative position of the supply and
demand curves
–To raise revenue for public purposes
–To influence market outcomes

Buyers and sellers share the tax burden
Market Efficiency
amount a firm receives for the sale of
its output.
Consumer surplus
–Amount a buyer is willing to pay for a good
minus amount the buyer actually pays
–Willingness to pay minus price paid
–Measures the benefit buyers receive from
participating in a market
Producer surplus
–Amount a seller is paid for a good minus the
seller’s cost of providing it
–Price received minus willingness to sell
Total surplus = Consumer surplus + Producer
surplus



Consumer surplus = Value to buyers –
Amount paid by buyers
Producer surplus = Amount received by
sellers – Cost to sellers
Amount paid by buyers = Amount received
by sellers
Total surplus = Value to buyers – Cost to
sellers
Total Revenue=Price×Quantity
Definition of total cost: the market value of
the inputs a firm uses in production.
Definition of profit: total revenue minus
total cost.
Profit=Total Revenue−Total Cost
B. Costs as Opportunity Costs
1.
1. Principle #2: The cost of something is
what you give up to get it.
2. The costs of producing an item must
include all of the opportunity costs of
inputs used in production.
3. Total opportunity costs include both
implicit and explicit
costs.
Definition of explicit costs: input costs
that require an outlay of money by
the firm
Definition of implicit costs: input
costs that do not require an outlay of
money by the firm.
C. The Cost of Capital as an Opportunity Cost
What Are Costs?
The opportunity cost of financial capital is an
important cost to include in any analysis of firm
performance.
The cost of something is what you give up to
get it.
D. Economic Profit versus Accounting Profit
CHAPTER 7: COST OF PRODUCTION
A. Total Revenue, Total Cost, and Profit
1.
1. The goal of a firm is to maximize profit.
Definition of total revenue: the
a. The slope of the production function
measures marginal product.
b. Diminishing marginal product can be seen
from the fact that the slope falls as the amount
of labor used increases.
Measures of Costs
Definition of economic profit: total revenue
minus total cost, including both explicit and
implicit costs.
From the Production Function to the TotalCost Curve
Definition of accounting profit: total revenue
minus total explicit cost.
A graph of the firm's total cost curve can be
drawn by plotting the level of output (x-axis)
against the total cost of producing that output
(y-axis).
A. Production Function
The Various Measures of Cost
Production function: the relationship
between quantity of inputs used to make a
good and the quantity of output of that
good.
Fixed and Variable Costs
Marginal product: the increase in output that
arises from an additional unit of input.
Fixed costs: costs that do not vary with the
quantity of output produced.
Variable costs: costs that do vary with the
quantity of output produced.
MarginalProductofLabor=changeinoutput÷c
hangeinlabor
Diminishing marginal product: the property
whereby the marginal product of an input
declines as the quantity of the input
increases.
Average and Marginal Cost
Average total cost: total cost divided by the
quantity of output.
Average fixed cost: fixed costs divided by the
quantity of output.
Average variable cost: variable costs divided
by the quantity of output.
Efficient scale: the quantity of output that
minimizes average total cost
3. The Relationship between Marginal Cost and
Average Total Cost
Marginal cost: the increase in total cost that
arises from an extra unit of production.
a. Whenever marginal cost is less than average
total cost, average total cost is falling.
Whenever marginal cost is greater than
average total cost, average total cost is rising.
b. The marginal-cost curve crosses the
average-total-cost curve at minimum average
total cost (the efficient scale).
Cost Curves and Their Shapes
1. Rising Marginal Cost
a. This occurs because of diminishing marginal
product.
b. At a low level of output, there are few
workers and a lot of idle equipment. As output
increases, the coffee shop gets crowded and
the cost of producing another unit of output
becomes high.
2. U-Shaped Average Total Cost
a. Average total cost is the sum of average
fixed cost and average variable cost.
1. Marginal cost eventually rises with output.
2. The average-total-cost curve is U-shaped.
3. Marginal cost crosses average total cost at
the minimum of average total cost.
Short Run and Long Run Cost
Costs in the Short Run and in the Long Run
b. AFC declines as output expands
and AVC typically increases as output
expands. AFC is high when output levels are
low. As output expands, AFC declines
pulling ATC down. As fixed costs get spread
over a large number of units, the effect
of AFC on ATC falls and ATC begins to rise
because of diminishing marginal product.
A. The division of total costs into fixed and
variable costs will vary from firm to firm.
B. Some costs are fixed in the short run, but all
are variable in the long run.
C. The long-run average-total-cost curve lies
along the lowest points of the short-run
average-total-cost curves because the firm has
more flexibility in the long run to deal with
changes in production.
Economies and Diseconomies of Scale
Economies and Diseconomies of Scale
1.
1. Economies of scale: the property
whereby long-run average total cost
falls as the quantity of output
increases.
2. Diseconomies of scale: the property
whereby long-run average total cost
rises as the quantity of output
increases.
3. Constant returns to scale: the
property whereby long-run average
total cost stays the same as the
quantity of output changes.