Welcome to Econ 1

Welcome to Day 10

Principles of Microeconomics

Price elasticity is the ratio of the percent change in quantity demanded to the percent change in price.

Elasticity of demand = percent change in quantity demanded divided by percent change in price.

Ed = %Qd % P

So a t-shirt shop notices that when they raise their price by 5%, they lose 10% of their customers. What is their elasticity of demand?

-10% = -25%What does the -2 mean?

For every 1 percent they raise their price, their sales drop by 2%.

The elasticity of demand number always means that for every 1% they raise their price, their sales drop by X%Another store checks their data and sees when they raise their price by 10%, they lose 5% of their sales. What is their elasticity of demand?

-5% = -0.510%For every 1% they raise their price, they lose 0.5% of their sales.

What if the stores lowered their price? Then a store with an elasticity of -2 should gain 2% in sales for every 1% drop in price. A store with an elasticity of -0.5 should gain 0.5% more sales with every 1 percent drop in price. Unfortunately, the data does not usually come in percentage terms. Usually you know the starting and ending prices, and the starting and ending quantities, and have to convert these to percentages. Heres how to do that.

%Qd = (Q2-Q1)/[(Q1+Q2)/2]

%P = (P2-P1)/[(P1+P2)/2]

So the elasticity formula in all its glory is

Ed = (Q2-Q1)/[(Q1+Q2)/2] (P2-P1)/[(P1+P2)/2]

The textbook writes it this way

Notice that we are calculating percentage changes in an unusual way. Usually, you would just divide the change by the starting value, not the average of the starting and ending value.

By doing it this way, we get the same elasticity answer if the price goes up from $10 to $12 or down from $12 to $10.The own price elasticity number will always be negative by the math, but it is common to drop the negative sign and write it as its absolute value. So -2 becomes 2. What is the range of possible own price elasticities?

0

81Ed < 1 then Inelastic DemandEd > 1 then Elastic DemandEd = 1 then Unit Elastic DemandTotal Revenue for a store isTR = P x Q

Imagine a store with a very inelastic demand, say 0.3 If they raise their price 10%, their sales drop by 3%. Does their revenue go up or down? TR ? = P 10% x Q 3%

TR goes up.

Whenever the elasticity is below 1, the percent drop in purchases is always less than the percent rise in price and revenue always rises when price rises.

What if the elasticity is greater than one? Then the percentage drop in sales is always greater than the percent rise in price and the revenue always fall.

TR ? = P 3% x Q 10%

TR goes down.

Inelastic DemandRaise price revenue goes up.Lower price revenue goes down.

Elastic Demand Raise price revenue goes down.Lower price revenue goes up.

And if the demand is unit elastic?Then the percentage change in price equals the percentage change in sales, and revenue remains unchanged.

Unit Elastic Demand (Ed = 1) Raise price revenue stays the same.Lower price revenue stays the same.What happens if zero customers stop buying when the price rises?

Ed = %Qd % P

Ed = 0.This is called perfectly inelastic demand.

Note that an Ed = 0 does not mean the store has 0 customers, it means it loses 0 customers then it raises its price. And what if the store loses every customer when it raises its price the tiniest possible amount?

As %P goes to 0, %Qd stays constant. This fraction is going to infinity. Ed = %Qd % P

Perfectly Inelastic Demand CurvePerfectly Elastic Demand CurveWhat determines if the elasticity is high or low?

1) Number and closeness of substitutes.2) Percentage of budget spent on the good.3) Time.1) Number and closeness of substitutes.

The more and better substitutes available for a good, the more consumers buy these substitutes in place of the good when the price of the good rises.Good substitutes high elasticityPoor substitutes low elasticity

Tell me some high and low elasticity items.

2) The percentage of your budget spent on the good.

When the price of the car you are thinking of buying doubles, you are more likely to back off buying it than when the price of a candy bar doubles.

The greater the percentage of your budget spent on the good, the higher its elasticity of demand.3) Time

The more time you have to respond, the higher the elasticity of demand.

What can you do if the price of gas rises?The textbook tells us that the short-run elasticity of demand for oil in the United States is .06, but the long-run elasticity is .45Reviewing the 3 factors that determine elasticity of demand.

1) Number and closeness of substitutes.2) Percentage of budget spent on the good.3) Time.What we learned today.1. What own price elasticity is and how to calculate it. 2. What inelastic and elastic demand mean and how they affect revenue when price rises.

Welcome to Day 11

Principles of Microeconomics

What we learned yesterday.1. What own price elasticity is and how to calculate it. 2. What inelastic and elastic demand mean and how they affect revenue when price rises. Income elasticity of demand is the percentage change in quantity demanded at a specific price divided by the percentage change in income that produced the demand change, all other things unchanged. Ei = %D D = Demand % I I = Income

What does the income elasticity number tell you?

It is the percent change in purchases if there is a 1 percent rise in income. For example, an answer of 0.7 means for every 1% rise in income, people buy 0.7 percent more of the good.When the income elasticity is positive, that means people buy more of the good when their income goes up or less when their income goes down. In other words, a normal good.

When the income elasticity is negative, people buy less when their income goes up, in other words, an inferior good.Cross price elasticity of demand is the percentage change in the quantity demanded of one good or service at a specific price divided by the percentage change in the price of a related good or service. EX,Y = %Dx % Py

Remember how to find the percentage change in X.

It is the change in X divided by the average of the starting and ending quantities of X. And dont forget to check for the sign.Cross-price elasticity is positive when the two goods are substitutes.

It is negative when the two goods are complements. Price elasticity of supply is the ratio of the percentage change in quantity supplied of a good or service to the percentage change in its price, all other things unchanged.

The terminology from the elasticity of demand transfers over to the elasticity of supply.

Es > 1 is Elastic SupplyEs < 1 is Inelastic Supply Es = 0 is Perfectly Inelastic SupplyEs = Infinity is Perfectly Elastic Supply.

Supply Curves and Their Price Elasticities

The more time suppliers have to build more factories, the greater the increase in the amount of the good will be in response to a given higher price. P1P2Which supply curve has the larger elasticity?Q CarsS1S2Elasticity and the War on Drugs

How can we spend so much money and manpower and drugs still be so readily available?http://www.drugsense.org/cms/wodclockHow do we represent the war on drugs in a supply and demand diagram?

Is the elasticity of demand for most illegal drugs going to be high or low?

Does cocaine have good substitutes or few substitutes?

D1 is low elasticity. D2 is high elasticity.

D1Q1Q2AQ2BHow much cocaine has been destroyed? What is the drop in usage?DQ1Q2Q1 to Q2 is the drop in usage = 25,000Amount destroyed = 125,000DQ1Q2So what has happened? Used to be 150,000 made and bought for 20 bucks. Now 250,000 is made, half is destroyed, and 125,000 is bought for $40.

The main effect of destroying drugs in this model is that more is made. What is the elasticity of cocaine in this model? Q1-Q2/[(Q1+Q2)/2] divided by P2-P1/[(P1+P2)/2] is(25,000/ 137,500)/(20/30)= .18/.67 = .2

What if the elasticity is high?

Q1 to Q2 is the drop in usage = 60,000Amount destroyed = 90,000DQ1Q2What is the elasticity of cocaine now?

Q1-Q2/[(Q1+Q2)/2] divided by P2-P1/[(P1+P2)/2] is(60,000/120,000)/(6/23)= .5/.26 = 1.92

Notice how much more the price rises when the elasticity is low.

What are some side effects of cocaine prices going high?Now lets look at the effect of government subsidized student loans.Students are given $300,000,000 to go to college (doubling current tuition spending)D1TuitionNumber StudentsNumber of students rises from 100,000 to 130,000. Tuition rises from $3,000 to $5,600.

Everyone gets to pay the higher tuition, not just the additional students. And dont forget, these are loans, so you still have to pay the money back.

So who is helped more by government guaranteed loans? The students or the colleges and banks?And this result is because of elasticity of supply. What if elasticity of supply is high? S

What we learned today.1. What income elasticity and cross price elasticity are.2. How elasticity of demand determine the effectiveness of the war on drugs and student loan programs.

Welcome to Day 12

Principles of Microeconomics

What we learned yesterday.1. What income elasticity and cross price elasticity are.2. How elasticity of demand determine the effectiveness of the war on drugs and student loan programs.

Were skipping chapters 6 and 7 for now, but we will come back to ch. 6 at the end of this unit and ch. 7 at the end of the class.

Instead were moving to chapter 8 to talk about production and cost. Weve already seen in our elasticity of supply discussion that time matters for how much is produced.

Two Time FramesShort-Run: Some inputs are fixedLong-Run: All inputs are variable Marginal Product of Labor (MPL) is the increase in total output gained by adding one more worker.

Q/LN Q MPL0 0 201 20 302 50 253 75 104 85N Q MPL0 0 201 20 302 50 253 75 104 85Why would MPL be rising?Specialization of Labor

1) Take advantage of natural abilities.2) More practice and training at specific jobs.3) Less time lost walking between jobs.N Q MPL0 0 201 20 302 50 253 75 104 85Specialization of Labor RegionN Q MPL0 0 201 20 302 50 253 75 104 85Specialization of Labor RegionWhy would MPL be falling?Diminishing Returns

As more variable factors are added to work with a fixed factor, eventually output rises at a diminishing rate. N Q MPL0 0 201 20 302 50 253 75 104 85Specialization of Labor RegionDiminishing Marginal Returns RegionProductivity of Labor Measured in MPLNow that we know what MPL is, here is a new statistic for you.

Average Product of Labor (APL) = Q/NAverage-Marginal Rule:

When the marginal is above the average, the average rises; when the marginal is below the averge, the average fall.

N Q MPL APL0 00 201 20 20 302 50 25 253 75 25 104 85 21.25Marginal and Average Product of Labor on the same graph.MPLMarginal and Average Product of Labor on the same graph.MPL

Output MPL

APL

Number WorkersWhat we learned today.1. What marginal product of labor is.2. How specialization of labor and diminishing marginal returns determine if MPL is rising or falling.3. The average-marginal rule and how to graph MPL and APL together.

Welcome to Day 13

Principles of Microeconomics

What we learned yesterday.1. What marginal product of labor is.2. How specialization of labor and diminishing marginal returns determine if MPL is rising or falling.3. The average-marginal rule and how to graph MPL and APL together.

I told you the productivity story just so I can tell you the cost story.

Fixed Costs (dont change as production varies): Lease PaymentsInterest on LoansSome Insurance

Variable Costs (do change as production varies):LaborSupplyElectricity QTFC TVC TC MC ATC0 100 0 100 -- - -1 100 20 12020 1202 100 35 13515 67.53 100 60 16025 53.34 100 100 20040 505 100 160 26060 52 If workers cost $10 each, how many workers did the firm hire to build 1 radio?

How about 2 radios?Why does it take 2 full workers to make the first radio, but only another 1.5 to make the second radio?

The workers must be getting more productive. Why would that be? Why does it take 2 full workers to make the first radio, but only another 1.5 to make the second radio?

The workers must be getting more productive. Why would that be? Specialization of LaborWhy does it take 4 workers to make radio 4, but 6 workers to make radio 5?Why does it take 4 workers to make radio 4, but 6 workers to make radio 5?

Diminishing Marginal ReturnsQTFC TVC TC MC ATC0 100 0 100 -- - -1 100 20 12020 1202 100 35 13515 67.53 100 60 16025 53.34 100 100 20040 505 100 160 26060 52Above the green line is SoL. Below is DMR. Marginal Cost and Average Total Cost on the same graph.MCMarginal Cost and Average Total Cost on the same graph.MCATCOutputDollarsFixed CostSpecialization of laborDiminishing Marginal ReturnsIn the short-run, the size of the factory is fixed.

In the long-run, the size of the factory can be varied.

The LRATC is made up of segments of the various possible SRATC curves.

Economies of Scale - LRATC is falling as you produce more in a larger factory.

Constant returns to Scale - LRATC is staying the same as you produce more in a larger factory.

Diseconomies of Scale - LRATC is rising as you produce more in a larger factory

Why Economies of Scale?

1) Specialization of Labor

2) Mass Production Techniques Assembly Lines

Why Diseconomies of Scale?

1) Command and Contr Control Problems

2) Law of Increasing Opportunity Cost Problems

Would you always want to produce in constant returns to scale since that is the lowest cost of production area?

Would you always want to produce in constant returns to scale since that is the lowest cost of production area?

No! How many customers you have and how much they are willing to pay matters also.Alright, so you learned all this about productivity and cost. What is the business actually going to do?

For that, we have to bring in the customers.Businesses operate in different environments, called market structures.

There are 4 market structures. Each market structure is defined by:1) How many firms sell in it.2) How close the firms products are to each other.3) How easy it is to get into or out of the market. The first market structure is Perfect Competition

1) Many sellers and buyers.2) Firms sell identical goods.3) There is easy entry/exit.Because there are many firms selling identical products, the sales price is the same for all firms.

These firms are called Price Takers.Perfect Competition examples are:

1) Small farms.2) Stockbrokers selling identical stock.3) Miners.4) Fishermen

A small wheat farmer has a demand curve that looks like this:

Demand Curve$5.98PQHes not worried that he will produce so much wheat he will drive the world price of wheat down.

The world demand curve for wheat is still downward sloping, but he is too small to make any difference.

Just like you buying potato chips.What we learned today.1. How to graph MC and ATC.2. What causes economies and diseconomies of scale.3. What perfect competition is and what its demand curve looks like.

Welcome to Day 14

Principles of Microeconomics

What we learned yesterday.1. How to graph MC and ATC.2. What causes economies and diseconomies of scale.3. What perfect competition is and what its demand curve looks like. Marginal Revenue is the increase in total revenue gained with each additional sale.

It is a before cost is taken out number.

For firms in perfect competition, marginal revenue = price.

A small wheat farmer has a marginal revenue curve that looks like this:

Demand Curve$5.98 Marginal = Revenue CurveQPThe farmer does not get to pick his price, but he does get to pick his quantity of wheat grown. He will do what makes him the most money. Q TR TC Price=$100 0 2 -2 TR = P x Q1 10 10 0 = Profit2 20 16 4 TR = Total 3 30 25 5 Revenue4 40 37 3 TC = Total CostQ TR TC MR MC 0 0 2 -2 -- --1 10 10 0 10 8 2 20 16 4 10 63 30 25 5 10 9 4 40 37 3 10 12

To maximize profit, produce the wheat that has MR>MC and dont produce the wheat that has MC>MR.

Dont sell any lemonade that costs more than 10 cents to make.

If you can produce fractions rather than just integers, then produce the level of output where MR=MC.

This is what the textbook calls the marginal decision rule.Just because you follow the marginal decision rule doesnt mean you necessarily make a positive profit. Sometimes the best you can do is to lose the least.Q TR TC MR MC 0 0 20 -20 -- --1 10 28 -18 10 8 2 20 34 -14 10 63 30 43 -13 10 9 4 40 55 -15 10 12What should you do here?Note that you cant avoid a loss by shutting down. If you shut down, you lose fixed cost.

Is there a way to know if you are making a profit or losing money just using the price and the ATC of production?

TR = P x QTC = ATC x Q TR = P x QTC = ATC x Q

The Qs will be the same for both equations. So if P>ATC, this firm is making money. If PATC.ATCMRMCQPQPHere we have a loss because ATC>P.ATC

What we learned today.1. What MR is and to produce the quantity where MR = MC.2. The firm makes a profit when P>ATC3. How to graph the Q and P of a business and if they are making a profit.

Welcome to Day 15

Principles of Microeconomics

What we learned yesterday.1. What MR is and to produce the quantity where MR = MC.2. The firm makes a profit when P>ATC3. How to graph the Q and P of a business and if they are making a profit. When should a firm just give up and shut-down?

When its loss from operating is greater than its fixed cost.

Firm 1Firm 2TR $400$400TFC $100$100TVC $395$405TC $495$505Profit $-95$-105

What should each firm do?

Keep operating when TR>TVC.

TR = P x QTVC = AVC xQ

Keep operating when P>AVCShutdown when P