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This 8 page Study Guide was uploaded by Emma Notetaker on Sunday November 29, 2015. The Study Guide belongs to ECON 1010 at Tulane University taught by Toni Weiss in Summer 2015. Since its upload, it has received 42 views. For similar materials see Intro to Microeconomics in Economcs at Tulane University.
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Date Created: 11/29/15
Exam 2 – Intro to Microeconomics 10/18/15 3:40 PM Consumer and Producer Surplus • consumer Surplus: difference between what you would have been willing to pay vs. what you get to pay o ex: finding out something you would have bought anyways was on sale o area above the price line and below the demand curve o you get ZERO consumer surplus for the last unit you buy – you’ve reached equilibrium price o we continue to consume until surplus is zero o bigger is demand curve is STEEPER (reservation price for the first few is VERY high o supply curve does not affect consumer surplus • producer surplus: difference between what a firm would be willing to sell a good for vs. what it actually got to sell it for o profit o area under the price and above the supply curve o usually on earlier units due to law of increasing opportunity cost (costs more as you go) o bigger when supply curve is steeper • total economic surplus = producer surplus + consumer surplus • greatest economic surplus occurs when: o marginal cost = marginal benefit o quantity demanded = quantity supplied • when demand decreases, both consumer and producer surplus decrease • deadweight loss: a loss of economic surplus due to some type of economic restriction in the market o area of graph to the right of consumer or producer surplus (to the left of equilibrium point o ex: price restriction, production restriction, not enough competition o potential that was there is now gone Restrictions: due to unfairness of market • price floor: minimum (legally mandated) price at which something can be traded o ex: minimum wage • price ceiling: legally mandated maximum price at which something can be traded • in states of emergency, prices become frozen (ex: generators in storms) • amount traded in market will be smaller of Qs or Qd Elasticity: a measure of responsiveness to a stimulus • formula: response o stimuli Price elasticity of demand: how responsive is quantity demanded to a change in price? • stimuli: change in price • response: change in quantity demanded • ALWAYS negative, so we take the absolute value • ep= % change in Q D • % change in price • to get rid of confusion caused by percentages, we use the midpoint formula: o ep = (Q1-Q2) o (Q1+Q2)/2 o (P2-P1) o (P1+P2)/2 • ep>1 à elastic (more responsive) o flatter curve • ep< 1 à inelastic (less elastic) o steeper curve • ep= 1 à unit elastic • you can only calculate price elasticity of demand between TWO points on the SAME demand curve o because the change % change is represented only on that one curve o if there are multiple curves, there must be another factor OUTSIDE of price • along any straight line, there is a segment that is elastic, a segment that is inelastic, and a point that is unit elastic o elastic – near the top o inelastic – near the bottom o unit elastic is the point of change between elastic and inelastic • perfectly elastic demand: horizontal line o for perfect substitutes o if a price changes even a little, demand drops to 0 o ex: 2 vending machines next to each other selling exactly the same thing (if the price of one rises, people will only buy from the other) o slope = 0 • perfectly inelastic demand: vertical line o no matter what the price is, demand will stay the same o necessities (otherwise you will die) o slope = infinity o ex: insulin • determinants of elasticity: o 1. needs (inelastic) vs. luxury (elastic) o 2. # of substitutes (more substitutes = more elastic) o 3. time (longer time period is more elastic- more time to find substitutes) o 4. % of budget (more expensive = more elastic) • who cares about price elasticity of demand? suppliers o customer loyalty – how loyal are customers to products o suppliers want LOW elasticity – to create relatively inelastic demand o more elastic leads to a decrease in TOTAL revenue for suppliers § people will not buy more at this price, less sold o total revenue: P*Q o e p 1 à % change in price < % change in Q (decreDse in total revenue) § price decrease pulls total revenue down and Q notd enough to pull it back up • income elasticity of demand: how responsive to change in income (y) • e = % change in Q y D % change in y • use midpoint formula: o = (Q1-Q2) (Q1+Q2)/2 (y2-y1) (y1+y2)/2 • normal goods: 0<ey<1 (positive income elasticity) • inferior goods ey < 0 (negative income elasticity) • luxury: ey>1 (largely positive elasticity) • cross price elasticity of demand: how responsive consumers are to a change in price of another good • has NOTHING to do with normality or inferiority • e ab= % change Q b o %change P a • e ab> 0 à substitutes (positive cross price elasticity) • e < 0 à complements (negative cross price elasticity) ab • unrelated goods have 0 cross price elasticity • utility: • marginal utility: extra satisfaction from consuming one more o mu = change in total utility • total utility: total satisfaction from consumption • law of diminishing marginal utility: marginal utility decreases with consumption (additional satisfaction decreases) o negative marginal utility ex: too much alcohol • when graphing total and marginal utility, use two different graphs (because of differences in scale) o utils: vertical axis o Q/time: horizontal axis • marginal utility is the derivative of total utility: o mu>0 and increasing: TU increases at increasing rate (concave up) o mu >0 and decreasing: TU increases at decreasing rate (concave down) o mu<0 and increasing: TU decreases at increasing rate (concave up) o mu<0 and decreasing: TU decreases at decreasing rate (concave down) • total utility increases until marginal utility becomes negative • rate of total utility (concavity) depends on whether marginal utility is increasing or decreasing • budget lines: combination os 2 goods a consumer can buy given his income and the prices of the 2 goods • every point on the line represents spending ALL money on combinations of the two goods • any point on the interior, not spending all the money • CAN’T afford points on exterior • to deal with weird fractions (ex: 3/5 of a muffin) change the TIME o ex: ½ muffin per week = 1 muffin every 2 weeks) • slope of budget line = income/Py o income/Px o OR Px/Py o slope is equal to the price of good on horizontal axis over price of good on vertical axis § relative price of good on x-axis § equal to opportunity cost of good on x-axis o tend to take absolute value because ALWAYS negative o everyone’s budget lines have EQUAL slopes o if income increases, line shifts right (left for decrease) § slope stays the same o if P increases à steeper line x o P yncreasesà flatter line • consumer goal is to maximize satisfaction and utility • there is some point on the graph where mu is equal for both x and y – after thie point they swap o mu inxreases as you go up o mu inyreases as you go down • rational spending rule: maximizes satisfaction o mu = xu y Px P y • law of demand hols with rational spending rule: if the price of one increases, that side will be larger. SO should buy more of one and less that the other • indifference curves: all combinations of 2 goods between which a person is completely indifferent • not indifferent to goods themselves, but to COMBINATIONS • each point has SAME level of satisfaction • different indifference curves represent different levels of satisfaction and utility • downward sloping • curved due to law of diminishing marginal utility • ALL points on a plane have an indifferent curve going through them o farther from origin = higher utility o closer to origin = lower utility • if COMPLETELY indifferent between goods (perfect substitutes) line would be linear • as you move down and right, mu of horizontal good decreases, mu of vertical good increases • most satisfaction at point where indifferent curve is TANGENT to budget constraint (slopes are EQUAL) à optimum satisfaction • marginal rate of substitution (MRS) = MUx/MUy • P x = MUx à PxMUy = PyMUx à rational spending rule! Py MUy • changes in price • increase in price causes inward shift in budget curve – we use a DIFFERENT indifferent curve o indifference curves CANNOT shift • income and substitution effects work together to give us the law of demand • income effect: change in purchasing power – due to rising prices • substitution effect: substitute AWAY from good that went up in price 10/18/15 3:40 PM 10/18/15 3:40 PM
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