BASIC MICROECONOMICS (BACR 2) REVIEWER
same with change in the
price.
Module 6 – 7: The Concept of Elasticity
A general definition:

“Elasticity” is a measure of the degree of sensitivity (or responsiveness) of one
variable to changes in another variable.

Elasticity is defined as a ratio of the percentage change in the dependent variable
to the percentage change in the independent variable

The price elasticity of Demand is a measure of the degree of sensitivity of
demand to changes in the price of product – X.
ep > 1
Relatively Elastic
Demand
The percentage change in
the quantity demanded of
a product is greater than
percentage change in its
price.
ep < 1
Relatively Inelastic
Demand
The change in the
demand of a product is
less than that of change in
its price.
Unitary Elastic Demand
The change in the
demand and change in
the price of a product is
same.
ELASTICITY
 A measure of a variable’s sensitivity to a change in another variable, most
commonly referring to demand as affected by other factors.
WHAT IS ELASTICITY?

Elasticity of Demand
 Is a measure of how much demand for a product changes when there is a
change in one of the factors that determines demand.
Price Elasticity of Demand (PED – Elastic or Inelastic?
 Price Elastic – if a small increase in price leads to a proportionally
large decrease in quantity demanded, consumers are said to be very
price sensitive.
 Price Inelastic – if a large increase in price has little effect on the
quantity of a good demanded, consumers are not very price
sensitive.
PED Coefficient
 Is negative because of the inverse relationship between price and
quantity.
 We typically ignore the negative and express PED as an absolute
value.
TYPES OF PRICE ELASTICITY OF DEMAND
Numerical Value
Type of Price Elasticity
Description
ep - ∞
Perfectly Elastic Demand
There is a greater change
in demand in response to
percentage of smaller
change in the price.
ep - 0
Perfectly Inelastic
Demand
This implies that
demand remains
the
the
ep - 1
PRICE ELASTICITY FORMULA
ep =
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
=
%△ 𝑄𝑑
%△ 𝑃
=
△𝑄
△𝑃
×
𝑃
𝑄
Where,
ep = Price Elasticity of Demand
Q = Original quantity demanded
△Q = Change in quantity demanded (Q1 – Q)
P = Original Price
△P = Change in price (P1 – P)
DEGREES OF PRICE ELASTICITY

Highly Elastic Demand
 Proportionate change in quantity demanded is more than a given change in
price.
 ep > 1 (in absolute terms)
 Such goods are called luxuries

Unitary Elastic Demand
 Proportionate change in price brings about an equal proportionate change
in quantity demanded.
 ep = 1 (in absolute terms)

Relatively Elastic Demand
 Proportionate change in quantity demanded is less than a proportionate
change in price.


 ep < 1 (in absolute terms)
 Such goods are called necessities
Perfectly Elastic Demand
 ep = ∞ (in absolute terms)
 Horizontal demand curve
 A negligible increase in price would result in zero quantity demanded.
Perfectly Inelastic Demand
 ep = 0 (in absolute terms)
 Vertical demand curve
 Such goods are termed neutral
ARC ELASTICITY METHOD
 Is also known as “Average Elasticity”
 Used when the available figures on price and quantity are discrete, and it is
possible to isolate and calculate the incremental changes.
eI =
=
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
×100%
𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝑐ℎ𝑛𝑎𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
×100%
𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒
=
=



𝑄2 − 𝑄1
𝑄1
𝑌2 − 𝑌1
𝑌1
△𝑄
△𝑌
×
𝑌1
𝑄1
eI > 0 (normal good)
eI > 1 (luxury good)
eI < 0 (inferior good)
ARC ELASTICITY FORMULA
EA =
Module 8 – 9: The Consumer Behavior
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐷𝑒𝑚𝑎𝑛𝑑
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑 + 𝑁𝑒𝑤 𝐷𝑒𝑚𝑎𝑛𝑑
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑃𝑟𝑖𝑐𝑒
𝑂𝑟𝑖𝑔𝑖𝑛𝑎𝑙 𝑃𝑟𝑖𝑐𝑒 + 𝑁𝑒𝑤 𝑃𝑟𝑖𝑐𝑒
E=
𝑄 − 𝑄1
𝑄 + 𝑄1
+
Definition:

the study of how individual customers, groups or organizations select, buy, use,
and dispose ideas, goods, and services to satisfy their needs and wants.

it refers to the actions of the consumers in the marketplace.

According to Engel, Blackwell, and Mansard – Consumer behavior is the actions
and decision processes of people who purchase goods and services for personal
consumption.
𝑃 − 𝑃1
𝑃 + 𝑃1
Where,
Q = Original quantity demanded
Q1 = New quantity demanded
P1 = Original price
P2 = New price
MIDPOINT METHOD
 Is the number halfway between the start and end values, the average of those
values.
CALCULATING PERCENTAGE CHANGES
Midpoint Method =
𝑒𝑛𝑑 𝑣𝑎𝑙𝑢𝑒 − 𝑠𝑡𝑎𝑟𝑡 𝑣𝑎𝑙𝑢𝑒
𝑚𝑖𝑑𝑝𝑜𝑖𝑛𝑡
× 100%
INCOME ELASTICITY OF DEMAND
 Measures how the quantity demanded of a good responds to a change in
income, ceteris paribus.
INCOME ELASTICITY FORMULA
THEORY OF CONSUMER BEHAVIOR
 Description of how consumers allocate incomes among different goods and
services to maximize their will-being.
Consumer behavior is best understood in three distinct steps:
1. Consumer Preferences
2. Budget Constraints
3. Consumer Choices
WHAT DO CONSUMERS DO?
 Recent models of consumer behavior incorporate more realistic assumptions
about rationality and decision making.
MARKET BASKETS
 Also known as “bundle”
 List of specific quantities of one or more goods
INDIVIDUAL PREFERENCES
1. Completeness
 Preferences are assumed to be complete.
 Consumers can compare and rank all possible baskets.
 By indifferent we mean that a person will be equally satisfied with
either basket.
2. Transitivity
 Preferences are transitive
 Transitivity is normally regarded as necessary for consumer
consistency.
3. More is better than less
 Goods are assumed to be desirable
 Consumers are never satisfied or satiated; more is always better,
even if just a little better.
INDIFFERENCE CURVE
 Curve representing all combinations of market baskets that provide a
consumer with the same level of satisfaction.
INDIFFERENCE MAP
 Graph containing a set of indifference curves showing the market baskets
among which a consumer is indifferent.
MARGINAL RATE OF SUBSTITUTION (MRS)
 Maximum amount of a good that a consumer is willing to give up in order to
obtain one additional unit of another good.
CONVEXITY
 When the MRS diminishes along an indifference curve, the curve is convex.
BADS

It explains that the
satisfaction level after
consuming a good or
service can be scaled in
terms
of
countable
numbers.
It explains that the
satisfaction
after
consuming a good or
service cannot be scales
in numbers, however,
these things can be
arranged in the order of
preference.
Example
Sam submits pizza gives
him 60 utils of satisfaction
whereas burger gives onlt
40 utils.
Sam submit, he gets more
satisfaction from Pizzas
as compare to the burger.
Measurement
‘Utility’ is measured on the
basis of ‘utils’
‘Utility’ is ranked on the
basis of ‘satisfaction’
It is less practical.
It is more practical and
sensible.
This theory was applied
by Prof. Marshall
This theory was applied
by J.R. Hicks and R.G.D.
Allen
Utility Analysis
Indifference
Analysis
Meaning
Realistic
Used by
Other Name
Curve
ORDINAL UTILITY FUNCTION
 Utility function that generates a ranking of market baskets in order of most to
least preferred.
Bad good for which less is preferred rather than more.
PERFECT SUBSTITUTES
 Two goods for which the marginal rate of substitution of one for the other is a
constant.
PERFECT COMPLEMENTS
 Two goods for which the MRS is zero or infinite; the indifference curves are
shaped as right angles.
CARDINAL UTILITY vs. ORDINAL UTILITY
BASIS
CARDINAL UTILITY
ORDINAL UTILITY
CARDINAL UTILITY FUNCTION
 Utility function describing by how much one market basket in preferred to
another.
UTILITY
 Numerical score representing the satisfaction that a consumer gets from a
given market basket.
 Is a term in economics that refers to the total satisfaction received from
consuming a good or service,
 Is another word for “happiness”
 An increase in utility means consumers are better off and decrease are worse.
UTILITY FUNCTION

Formula that assigns a level of utility to individual market baskets.
BUDGET CONSTRAINTS
 Constraints that consumer face as a result of limited incomes.
BUDGET LINE
 All combinations of goods for which the total amount of money spent is equal
to income.
 Describes the combinations of goods that can be purchased given the
consumer’s income and the prices of the goods.
INCOME CHANGES
 Causes the budget line to shift parallel too the original line.
PRICE CHANGES
 Causes the budget line to rotate about one intercept.
MARGINAL BENEFIT
 Benefit from the consumption of one additional unit of a good.
MARGINAL COST
 Cost of one additional unit of a good.
MARGINAL UTILITY (MU)
 Additional satisfaction obtained from consuming one additional unit of good.
 Refers to the change in total utility as an individual consumes each additional
unit of the commodity.
Marginal Utility =
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑁𝑜.𝑜𝑓 𝑈𝑛𝑖𝑡𝑠 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑑 (△𝑇𝑈)
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑇𝑜𝑡𝑎𝑙 𝑈𝑡𝑖𝑙𝑖𝑡𝑦 (△𝑄)
or
Marginal Utility =
(𝑇𝑈𝑓 − 𝑇𝑈𝑖)
(𝑄𝑓 −𝑄 𝑖)
DIMINISHING MARGINAL UTILITY
 Principle that as more of a good is consumed, the consumption of additional
amounts will yield smaller additions to utility.
EQUAL MARGINAL PRINCIPLE
 Principle that utility is maximized when the consumer has equalized the
marginal utility per dollar of expenditure across all goods.
CONSUMER EQUILIBRIUM
 The solution to the consumer’s problem, which entails decisions about how
much the consumer will consume several goods and services.
MAXIMIZE TOTAL UTILITY
 When the consumers make choices about the number of goods and services
to consume, it is presumed that their objective is to maximize total utility.
SATURATION POINT
 Is a situation in which the product has reached all the potential customers and
the demand of the products is now less than the supply of the products.
TOTAL UTILITY
 Is the sum total of utility derived from each unit of a commodity.
 Is the aggregate amount of satisfaction or fulfillment that a consumer receives
through the consumption of a specific good or service.
LAW OF DIMINISHING MARGINAL UTILITY
The law states that as the quantity consumed of a commodity goes on
increasing, the utility derived from each successive unit consumed goes on decreasing,
consumption of all other commodities remaining constant.
UTILITY MAXIMIZATION RULE
A consumer should buy goods up to the point where the last money spent on
every good provided the same marginal utility as the last money spent in every other
good.
Module 10 – 11: The Organizations of Firms and Productions Costs
1.
2.
SOLE PROPRIETORSHIP – this is the simplest form of business
organization: only individual owns the business.
PARTNERSHIP – This refers to an association of two or more persons to carry