Chapter 4: Elasticity


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1 Chapter : Elasticity Elasticity of eman: It measures the responsiveness of quantity emane (or eman) with respect to changes in its own price (or income or the price of some other commoity). Why is Elasticity Important? How oes a firm go about etermining the price at which they shoul sell their prouct in orer to maximize total revenue? Total Revenue uantity You are a marketing manager for Intel A new computer chip has been evelope ecision to Be Mae o you sell the new chip at a high price ($)? o you sell the new chip at a low price ($)? eman an Total Revenue a uantity (millions of chips per year) eman an Total Revenue eman an Total Revenue a b uantity (millions of chips per year) uantity (millions of chips per year) b uantity (millions of chips per year)
2 Slope epens on Units of Measurement In these two examples, we can compare the slopes of the eman curves We cannot o so if we are ealing with ifferent goos an services. Or whenever the unit of measurement has been change. Effect of a change of unit of measurement on Slope uantity Slope epens on Units of Measurement In these two examples, we can compare the slopes of the eman curves We cannot o so if we are ealing with ifferent goos an services. Or, whenever the unit of measurement has been change. Elasticity is inepenent of the units of measurement. elasticity of eman A measure of the responsiveness of the quantity emane of a goo to a change in its own price (ceteris paribus). Elasticity: A UnitsFree Measure ercentage Change in uantity emane ε ercentage Change in Δ Elasticity of eman Calculating Elasticity The changes in price an quantity are expresse as percentages of the average price an average quantity. This way we avoi having two values for the price elasticity of eman for the same range of the eman curve
3 Example: Suppose, quantity emane changes from to when increases from to ollars. Fin out the price elasticity of eman for this specific range of the eman curve. ε Δ.... Calculating the Elasticity of eman Original a uantity (millions of chips per year) Calculating the Elasticity of eman Calculating the Elasticity of eman Original Δ $ Original New New a a uantity (millions of chips per year) Δ uantity (millions of chips per year) Calculating the Elasticity of eman Δ $ ave $ Original New a Δ uantity (millions of chips per year) Δ $ ave $ Original ave New a Δ uantity (millions of chips per year)
4 Calculating Elasticity ercentage Change in uantity emane ε ercentage Change in % Δ %Δ Δ /  / Inelastic an Elastic eman Three eman curves that cover the entire range of possible elasticities of eman: erfectly inelastic Unit elastic erfectly elastic erfectly inelastic eman Implies that quantity emane remains constant when price changes occur. elasticity of eman ε Δ Elasticity erfectly Inelastic uantity ε Unit Elastic eman Unit elastic eman Implies that the percentage change in quantity emane equals the percentage change in price. elasticity of eman  Δ Elasticity  Unit Elasticity uantity
5 erfectly elastic eman Implies that if price increases by any percentage, quantity emane will fall to an if price ecreases by any percentage, quantity will rise to infinity. elasticity of eman ε Δ erfectly Elastic eman Elasticity erfectly Elastic uantity Inelastic an Elastic eman Inelastic eman Implies the percentage change in quantity emane is less than the percentage change in price. In absolute sense, price elasticity of eman > an < Elastic eman Implies the percentage change in quantity emane is greater than the percentage change in price. In absolute sense, price elasticity of eman > ε Δ Elasticity Along a Straight Elasticity Along a StraightLine eman Curve uantity (millions of chips per year) Elasticity Along a StraightLine eman Curve Elasticity  Lowering the price Elastic from $ to $ results in a price elasticity of eman of . Elasticity Along a StraightLine eman Curve Lowering the price from $ to $ results in a price elasticity of eman of /. Inelastic Elasticity / uantity (millions of chips per year) uantity (millions of chips per year)
6 Elasticity Along a StraightLine eman Curve Elasticity > Elasticity Lowering the price from $ to $ results in a price elasticity of eman of . Elasticity < uantity (millions of chips per year) Elasticity, Total Revenue an Expeniture TR x Elastic eman a percent ecrease in price will result in a greater than percent increase in quantity emane. Total revenue will increase Unit elastic eman a percent ecrease in price will result in a percent increase in quantity emane Total revenue will not change ε Δ Elasticity, Total Revenue an Expeniture Inelastic eman a percent ecrease in price will result in a less than percent increase in quantity emane. Total revenue will ecrease ε Δ Elasticity, Total Revenue Elasticity, Total Revenue an Expeniture Total Revenue Test elasticity of eman can be estimate by observing the change in total revenue that results from a price change (ceteris paribus). Elasticity, Total Revenue & Expeniture Total Revenue Test cut an total revenue increases eman is elastic. cut an total revenue ecreases eman is inelastic cut an total revenue oes not change eman is unit elastic TR x
7 Elastic eman Unit elastic Inelastic eman Total Revenue (billions of ollars) TR uantity (millions of chips per year) When eman is elastic, price cut increases total revenue Total Revenue (billions of ollars) Maximum total revenue When eman is inelastic, price cut ecreases total revenue uantity (millions of chips per year) More Elasticities of eman Cross elasticity of eman Measures the responsiveness of the eman for a goo to a change in the price of a substitute or complement goo. Income Elasticity of eman Income elasticity Measures the responsiveness of the eman to a change in income. Cross elasticity of eman ercentage change in eman ercentage change in price of a substitute or complement ercentage change In eman Income elasticity of eman ercentage change in income Income Elasticity of eman Income elasticity can be: ) Greater than (normal goo, income elastic) luxury goos  ocean cruises, jewelry ) Between zero an (normal goo, income inelastic) necessities  foo, clothing ) Less than zero (inferior goo) potatoes, rice Unit Tax an Tax Buren: $ S S uantity
8 Unit Tax an Tax Buren: Elasticity an Tax Buren: erfectly Inelastic eman $ Consumers part S S $ Consumers part S S Suppliers part uantity uantity Elasticity an Tax Buren: erfectly Elastic eman Elasticity an Tax Buren: erfectly Elastic Supply $ roucers part S S $ Consumers part S S uantity uantity Elasticity an Tax Buren: erfectly inelastic Supply $ roucers part S uantity Chapter Marginal Utility & Consumer Choice:
9 Utility: The satisfaction or enjoyment a person obtains from consuming a goo. Util: A hypothetical unit use to measure how much utility a person obtains from consuming a goo. Marginal Utility: The change in total utility a person erives from consuming an aitional unit of a goo. Total Utility: The total number of utils a person erives from consuming a specific quantity of a goo. Law of iminishing Marginal Utility: Total an Marginal Utility The iea that as more of a goo is consume, the utility a person erives from each aitional unit iminishes. Wateriamon araox: How much people value a goo epens upon the utils they erive from the last unit consume or the Marginal Utility. Making selection from a given buget: MU of ears MU of Apples MU/ of ears MU/ of Apples / / / / / / / /
10 Making selection from a given buget: Clothes Utils MU/ Amusement Utils MU/ % Sale on Clothing: Clothes Utils MU/ Amusement Utils MU/ MU/ Equalization rinciple: Consumer Surplus: MU MU MU ( clothes ) ( amusement) ( any other goo) The ifference between the maximum amount a person woul be willing to pay for a goo or service an the amount the person actually pays. uantity uantity
11 Chapter : Civilian Goos Ceilings an Floors efense Goos S S ($) S ($) Ceiling Ceiling uantity (,) Excess eman or Shortage uantity (,) ($) S Excess Supply or Surplus S Floor ($) Excess Supply or Surplus S Floor uantity (,) uantity (,)
12 Chapter Costs of rouction What is a Fixe Cost? Cost to a firm that oes not vary with the quantity of goos prouce What are examples of Fixe Costs? rent or mortgage a part of utilities Fixe Costs are also known as.. Sunk Cost What is a Variable Cost? Cost that varies with the quantity of goos prouce What are examples of Variable Costs? worker s wages raw materials some utilities some taxes
13 What is Labor rouctivity? The output per laborer per hour Uner what conition is it cheaper to pay $ an hr. to a U.S. worker than $ an hour to a foreign worker? If the U.S. worker is more than times as prouctive as the foreign worker Why o labor costs per unit of output changes as more units of labor are hire? of labor increases uality of labor ecreases Labor prouctivity Changes Why o nonlabor, variable costs per unit of output increase as output increases? Resources become more scarce oes the cost of all resources increase more than prouction increases? No, the costs of some resources may vary proportionately with the level of prouction
14 What is Total Variable Cost? The sum of specific variable costs in the firm s cost structure $ Total Variable Costs What are Total Costs? Cost to the firm that inclues both fixe an variable costs $ Total Costs TC TVC TFC What is Average Total Cost? Total cost ivie by the quantity of goos prouce $ ATC /. ATC /. TC TVC
15 $ ATC What is Average Variable Cost? Total variable cost ivie by the quantity of goos prouce $ $ TVC ATC AVC What is Average Fixe Cost? Total fixe cost ivie by the quantity of goos prouce Costs AFC uantity
16 What is Marginal Cost? The change in total cost associate with one more unit of prouction If the only thing we observe is a change in total cost associate with a small change in output prouce then MC is compute in the following way. MC TC $ MC / TC $ TC TC, TVC, $ TFC TFC MC ATC AVC MC ATC AVC AFC
17 $ MC ATC AVC What is the Short Run? A time perio in which proucers can change some, but not all of its resources What is the Long Run? The time perio in which proucers can change quantities of all resources Shortrun run Vs. Longrun Average Cost $ per unit of Output SRAC A SRAC B SRAC C SRAC LRAC What are Economies of Scale? When a firm increases resources in the long run an ATC ecreases What are iseconomies of Scale? When a company increases resources in the long run an ATC increases
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