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Ashegian
Exam 1 Spring 2011
173
Economics
Graduate
02/18/2011

Additional Economics Flashcards

 


 

Cards

Term
What is economics?
Definition

 

ØThe study of the allocation of scarce resources to satisfy human’s alternative wants
Term

 

Basic Concepts
The three main functions of management
Definition

 

Planning, Execution, and control
Term

 Basic Concepts

 

Managerial economics
Definition

 

is the application of economic theory to solve business problems
-
ØThe techniques learned in managerial economics can also be applied to nonprofit organizations.
Term

Basic Concepts

 

What is a Theory?
Definition

 

1.1. A theory is an abstraction from reality.
2.2. A theory is based on certain simplifying assumptions.
3.3. The test of the usefulness of a theory is its power to predict.
4.4. We continue to use a theory until certain events falsify it. In this case a new theory replaces the old one.
Term

Basic Concepts

What is the major difference between microeconomics and macroeconomics?
Definition

 

1.
2.Macroeconomic theory: big picture of the economy.
Microeconomic theory: small picture of the economy.
Term

 

How Is Managerial Economics Useful?
 
ØEvaluating Choice Alternatives
l
Definition

Identify ways to efficiently achieve goals.

lSpecify pricing and production strategies.
lSpell out production and marketing rules to maximize profits.
Term

 

How Is Managerial Economics Useful?
Making the best decisions
Definition

 

lManagerial economics helps meet management objectives efficiently.
lManagerial economics shows the logic of consumer,  and government decisions.
Term
Management decision problems
Definition
  • Product selection, output, and pricing
  • Internet Strategy
  • Organization Design
  • Product development and promotion strategy
  • Worker hiring and training
  • Investment and financing
Term
Economic Concepts
Definition
  • Marginal analysis
  • Theory of consumer demand
  • Theory of the firm
  • Industrial organization and firm behavior
  • Public choice theory

 

Term
Quantitative Methods
Definition
  • Numerical analysis
  • statistical estiamtion
  • forecasting procedures
  • game-theory concepts
  • optimization techniques
  • information systems

 

Term
Theory of the Firm
Definition

 

The basic model of business enterprise is called the theory of the firm.

Term

Theory of Firm

 

Primary objective

Definition
Long-term expected value maximization
Term

Theory of Firm

 

 Value of Firm

Definition
present value of the firm's expected future cash flows
Term

Theory of the firm

 

 Present Value

Definition
the value of the expected cash flow discounted back to the present at an appropriate interest rate
Term
The corporation is a legal device
Definition

Firm

- investors

- society

- suppliers

- management

- customers

- employees

Term

Theory of the Firm

 

Expected Value Maximization

Definition
  • owner-mangers maximize short-run profits
  • primary goal is longterm expected value maximization
Term
Constraints and the theory of the firm
Definition
  • technology
  • resource scarcity
  • contractual obligations: work scheduling, work assignemtns
  • laws & regulation: minimum wage, health and safety standard, pollution emission standard
Term
Limitations of the theory of the firm
Definition

 

l- Alternative theory adds perspective:
Optimize: Seek the best solution
satisfice : Seek satisfactory rather than optimal solution
Size or growth maximization
Personal utility or welfare maximization
l- Competition forces efficiency.
l- Hostile takeovers threaten inefficient managers
Term

 

THE EQUATION FOR THE VALUE OF THE FIRM
Definition

Value of the firm = present value of expected future profits

 

 

Term

 

Cost & Profit
Producers:
Definition

 

Maximize profit
Term

Cost and Profit

 

 

ØOpportunity cost
Definition

 

lAll resources have an opportunity cost
Term

Cost &Profit

 

Explicit Costs

Definition
Payments for resources
Term

Cost & Profit

 

Implicit Costs

 

Definition

- Opportunity costs or resources owned by the firm/firm owners

 

- No Cash payment

Term

Profit Measurement

 

Business (accounting) profit

Definition

Total revenue -- Explicit costs

(minus)

Term

Profit Measurement

 

Economic Profit

Definition

Total revenue -- all costs (implicit and explicit)

                     (minus)

Term

Profit measurement

 

normal profit

Definition

 

lThe business profit just sufficient to ensure all resources used by the firm earn their opportunity costs.
Term

Profit measurement

 

Economic Profit

Definition

 

  • l
  • lProfit above a risk-adjusted normal return.
  • lConsiders cash and noncash items.
Accounting profit – Normal profit.
Term

Profit Measurement

 

Profit Margin

Definition

 

Ø(Business Profit/Sales) X 100
Term

Profit Measurement

 

 

Return on Stockholder’s Equity (ROE): 
Definition

 

Ø(Net Income/(the book value of assets – total liabilities)
Term

Profit Measurement

 

 

ØVariability of Business Profits
Definition

 

Business profits vary widely
Term

 

Profit Measurement: Example
Definition

 

Total revenue

 

$105,00
Less explicit costs:
  Assistant’s salary
  Material and equipment
 
$21,000
$20,000

 

Equals accounting profit

 

$64,000
Less implicit costs:
  Wanda’s forgone salary
  Forgone interest on         savings 
  Forgone garage rental
$50,000
$1,000
$1,200

 

Equals economic profit

 

$11,800
Term

 

Why Do Profits Vary Among Firms?
 
Disequilibrium Profit Theories
Definition

 

l
lUnexpected cost savings
Unexpected revenue growth
Term

 

Why Do Profits Vary Among Firms?
 
ØCompensatory Profit Theories
Definition

 

lProfits accrue to firms that are better, faster, or cheaper than the competition
Term

 

Role of Business in Society
 
Why Firms Exist
Definition

 

lBusinesses help satisfy consumer wants.
lBusinesses contributes to social welfare
Term

 

Role of Business in Society
 
Social Responsibility of Business
Definition

 

lServe customers
lProvide employment opportunities
lObey laws and regulations
Term

Business and Social Environment

 

Technology

 

Definition

- Production capacity

- Worker knowledge

- Communications capability

- Research and development

Term

Business and Social Environment

 

Market Environment

Definition

Customer Demand

Level of competition

Supplier Capability

Term

Business and Social Environment

 

Legal Environment

Definition

Tax burden

Regulatory policy

Trade policy

Term

Business and Social Environment

 

Competitive Strategy

Definition

Product choice

Pricing strategy

promotion strategy

Term

Business and Social Environment

 

Organization Design

Definition

Assignment of decisions rights

Match worker incentives with managerial motives

Decision management and control

Term
Objective of Ch 1
Definition
    • l
    Learn usefulness of economics in describing managerial behavior.

  • lAppreciate how economics can be used to improve managerial decisions.
  • l
  • Understand vital role of business in society.

Term
Chapter 1 key concepts
Definition

Ømanagerial economics

Øtheory of the firm
Øexpected value maximization
Øvalue of the firm
Øpresent value
Øoptimize
Øsatisfice
Ø
normal rate of return
Øeconomic profit
Øprofit margin
Øreturn on stockholders' equity
Øfrictional profit theory
Ømonopoly profit theory
Øinnovation profit theory
Øcompensatory profit theory
business profit
Term

Econ Optimization Ch 2

 

Overview

Definition

 

ØEconomic Optimization Process
ØRevenue Relations
ØCost Relations
ØProfit Relations
ØIncremental Concept in Economic Analysis
Term

Chapter 2

 

Key Concepts

Definition

 

Øoptimal decision
Øspreadsheet
ØEquation
Ødependent variable
Øindependent variable
Ømarginal revenue
Ørevenue maximization
Øcost functions
Øshort-run cost functions
Ølong-run cost functions
Øshort run
Ølong run
Øtotal costs
Øfixed costs
Ø
variable costs marginal cost Øaverage cost Øaverage cost minimization Øtotal profit  Ømarginal profit Øprofit maximization rule ØBreak even point
Term

 

Economic Optimization Process
 
Optimal Decision
Definition

The decision alternative that produces a result most consistent with managerial objectives:

1.Tables: The simplest and most direct form for listing economic data.
2.Graphs: Visual representation of the data.
3.Equations.
Term

 

Functional Relations: Equations
Definition

- The easiest way to examine basic economic concepts is to consider functional relations incorporated in the basic valuation model.

Ø- TR = f(Q) : General form.
Ø- TR = P x Q Specific form.
Ø- If Price is constant at $1.50 regardless of quantity, we have TR = 1.50 X Q
Ø- Data in Table 2.1 are specified by the above equation and graphically presented in Figure 2.1
Term

 

Relation Between Total Revenue and Output
Definition

Table 2.1
Total Revenue Output
$1.50 1
3.00 2
4.50 3
6.00 4
7.50 5
9.00 6

 

Term

 

Revenue Relations
Price and Total Revenue
Definition

 

lTotal Revenue = Price ´ Quantity.
lTR= P ´ Q
Term

Revenue Relations

 

Marginal Revenue

Definition

 

lChange in total revenue associated with a oneunit change in output.
lChanges in the dependent variable caused by a one-unit change in an independent variable.
lMR = ∆TR/ ∆Q
Term

Revenue Relations

 

Revenue Maximization

Definition

 

Activity level (or quantity) that generates the highest revenue,
MR = 0
Term

Revenue Relations

 

Do Firms Really Optimize?

 

Definition

 

  • lInefficiency and waste lead to failure.
  • l
  • Optimization techniques are widely employed by successful firms.
Term
Relation Between Price and Output
Definition
Draw chart
Term
Relationship between price, total revenue, marginal revenue and output
Definition
Draw Chart
Term

Cost Relations

 

Total Cost

Definition

 

lTotal Cost = Fixed Cost + Variable Cost.
lTC = TFC + TVC
Term

Cost Relations

 

Marginal and Average Cost

Definition

 

lMarginal cost is the change in total cost associated with a oneunit change in output:
lAverage Cost = Total Cost/Quantity
AC = TC / Q
MC = ∆TC / ∆Q
Term

Cost Relations

 

More Info

Definition

- Average Cost Minimization

Ø
Ø- Average cost is minimized when MC = AC.
Ø- Reflects efficient production of a given output level.
Term

Profit Relations

 

Total and Marginal Profit

Definition

 

l
lMarginal profit is the change in total profit due to a one-unit change in output,
Mπ = MR - MC.
Π = TR -TC
Total Profit (π ) = Total Revenue - Total Cost.
Term

Profit Relations

 

Profit Maximization

Definition

 

lProfit is maximized when Mπ = MR – MC = 0 or  MR = MC, assuming profit declines as Q rises.
Term

Profit Relations

 

Marginal VS Incremental profits

Definition

- Marginal profit is the gain from producing one more unit of output (Q).

l- Incremental profit is the profit gain or loss with a given managerial decision possibly involving multiple units of Q.
l- When incremental profit is positive total profit increases.
l- When incremental profit is negative, total profit declines.
Term

 

MARGINALS AS THE DERIVATIVES OF FUNCTIONS
Definition

 

Y = f(X)
- The ratio ∆Y / ∆X is a general specification of the marginal concept: Marginal Y = ∆Y / ∆X.
- For example: ∆Y / ∆X = (Y2 –Y1)/(X2 – X1)
- A derivative is a precise specification of the marginal relations.
- The mathematical notation for a derivative is:
Consider the following general function:
Term

 

Changing          over the Range of a Curve
Definition
Draw Chart
Term

 

Finding Maximums or Minimums
Definition

 

- The maximization or minimization of a function occurs when its derivative or marginal value is equal zero.
- Consider the following profit function:
~ π = -$10,000 + $400Q - $2Q2
- Marginal Profit (M π) = dπ/dQ = $400 -$4Q
- Setting marginal profit equal to zero results in:
~ $400 - $4Q = 0
            $4Q = $400
                Q = 100 units
Term

 

Distinguishing Maximum from Minimums
Definition

- Second derivative ( the derivative of a marginal relations) is used to distinguish maximums from minimums.

- Suppose total profit is given by the following equation (Figure 2.6):
~ π = a – bQ + cQ2 – d Q3 
- First Derivative: dπ/dQ= (Mπ) = -b + 2cQ -3dQ2.
- Second Derivative: d2π/dQ2 = dMπ/dQ = 2c-6dQ.
- Second derivative is always positive at min. and negative at max.
Term

 

Numerical Example of Max./Min.
Definition

- Assume the total profit function illustrated in figure 2.6 is:

- Total Profit = π = $ -3000 -$2400Q +$350Q2 – $8.33Q3
- Marginal Profit = Mπ = d π /dQ = -$2400 + 700 Q – 25Q2
- Mπ = 0 =– 25Q2 + 700 Q -$2400 = 0
- Using the formula for a quadratic function we find: Q1= 4 units; Q2= 24 units.
- Second Derivative: dMπ/dQ2 = d2π /dQ2 = $700 - 50 Q.
- At Q1=4, the second derivative is $500, indicating a minimum.
- At Q2= 24, the second derivative is - $500, indicating a maximum.
Term

 

Use of Marginals to Maximize the Difference Between Two Functions
Definition
    Profit Maximization : MC=MR

  • Break Even Point: π = TR –TC = 0
  • Revenue Maximization : MR = 0
  • Average Cost Minimization: AC = MC
  • Figure 2.7 illustrates these concepts.
Term
Normal Rate of Return Chapter 1 Definitions
Definition
Average Profit necessary to attract and retain investment
Term

Incremental Concept in Economic Analysis

 

Incremental Change

CH 2

Definition
Change resulting from a given managerial decision
Term

Incremental Concept in Economic Analysis

 

Incremental Profit

Ch 2

Definition
Gain or loss associatied with a given managerial decision
Term

Why do profits vary amony firms?

 

Frictional Profit Theory

 

Ch 1

Definition
Abnormal profits observed following unaticipated changes in demand or cost conditions
Term

Why do profits vary amony firms?

 

Monopoly Profit Theory

ch 1

Definition
Above- normal profits caused by barriers to entry that limit competition
Term

Why do profits vary amony firms?

 

Innovation Profit Theory

ch 1

Definition
Above-normal profits that follow sucessful invention or modernization
Term

Revenue Relations

 

Total Revenue

Ch 2

Definition
Is a function of output
Term

Revenue Relations

 

Dependent Variable

Ch 2

 

Definition
Y-Variable determined by x-values
Term

Revenue Relations

 

Independent Variable

Ch 2

Definition
X-Variable determined separately from the y-variable
Term

Cost Relations

 

Cost Functions

Ch 2

Definition
Relations between cost and output
Term

Cost Relations

 

Short-run cost function

Ch 2

Definition
Cost relations when fixed costs are present; used for day-to-day operating decisions
Term

Cost Relations

 

Long-run cost function

ch 2

Definition
Cost relation when all costs are variable; used for long-term planning
Term

Cost Relations

 

 

Short-Run

Ch 2

Definition
Operating period during which the availability of at least one inpt is fixed
Term

Cost Relations

 

Long Run

Ch 2

Definition
Period of complete flexibility with respect to input use
Term

Cost Relations

 

Average Cost Minimization

Ch 2

Definition
Activity level that generates the lowest average cost, MC= AC
Term

Profit Relations

 

Total Profit

Ch 2

Definition
Difference between total revenue and total cost
Term

Profit Relations

 

Marginal Profit

Ch 2

 

Definition

Change in total proftit due to a 1-unit change in output

 

M(PIE)=MR-MC

Term

PROFIT RELATIONS

 

Profit Maximization rule

 

Ch 2

Definition

Profit is maximized when M(pie) =MR - MC = 0

 

Or MR=MC, assuming profit declines with further expansion in Q

Term

Profit Relations

 

Break-even points

Ch 2

Definition
Output levels with zero profit
Term

Chapter 3

 

Overview

 

 

Definition

1. Basis for demand

2. Market demand function

3. Demand curve

4. Basis for supply

5. Market supply function

6. Supply curve

7. Market equilibrium

 

Term

Basis for Demand

 

Ch 3

 

Direct Demand

 

Definition

 

Øis a relation that shows various quantities of a good that buyers are willing and able to buy at different level of prices during a given period of time, assuming that other things stay the same .
Other Things: Income, tastes and preferences, prices of related goods, population and price expectations.
Term

Basis for Demand

 

CH 3

 

Utility (satisfcation)

Definition
  • Indicates the worth of a good or service and it is the prime determinant of direct demand
  • Subjective Satisfaction derived from consumption
Term

Basis for Demand CH 3

 

Derived demand

Definition

 

is the demand for all inputs and is determined by the profitability of using various inputs to produce products
Term

Basis for Demand CH 3

 

Demand Function

Definition
Relation between quantity sold and factors influencing its level
Term

Basis for demand

 

ch 3

 

Direct Demand

Definition

 

Øis the demand for products that directly satisfy consumer desires
Term

Basis for demand Ch 3

 

Market Demand

Definition

 

is the horizontal summation of the individual demand curves at each price level
 
ØThe market demand function for a product is a statement of relation between the aggregate quantity demanded and all factors that affect this quantity.
Term

Basis for demand CH 3

 

Law of demand

Definition

 

The quantity demanded of a commodity varies inversely with its price, assuming that all other factors that may determine demand stay the same
Term

Demand curve ch3

 

Deman curve

Definition
relation between price and the quantity demanded, holding all else constant
Term

Demand curve ch 3

 

Change in the quantity demanded

Definition

movement along a given deman curve reflecting a change in price

 

 

lQuantity demanded falls if price rises.
lQuantity demanded rises if price falls
Term

Demand curve ch 3

 

Shift in demand (change in demand, role of non-price variables)

Definition

switch from one demand curve to another following change in a nonprice determinant of demand

 

Change in non-price variables will define a new demand curve
Term

 

Relation Between the Demand Curve and Demand Function Ch3
 
ØMovements Along Demand Curve
Definition

 

lA rise in price causes upward movement along a given demand curve.
lA price decline causes downward movement along a given demand curve.
Term

Relation Between the Demand Curve and Demand Function

Ch 3

 

ØDemand Curve Shifts

 

Definition

 

lDemand increases if a non-price change allows more to be sold at every price.
lDemand decreases if a non-price change causes less to be sold at every price.
Term

Utility Analysis ch 3

 

Assumption

Definition

 

lTaste are given
lTastes are relatively stable
Term

 

The Law of Diminishing Marginal Utility Ch 3
 
ØTotal utility
Definition

 

lTotal satisfaction
Term

The Law of Diminishing Marginal Utility Ch 3

 

Marginal Utility

Definition

 

lChange in total utility from one-unit change in consumption
Term

The Law of Diminishing Marginal Utility Ch 3

 

The more of a good consumed

Definition

 

The smaller the increase in total utility
Term

The Law of Diminishing Marginal Utility Ch 3

 

 

ØMarginal utility from each additional unit
Definition

 

lDeclines as more is consumed
Term

The Law of Diminishing Marginal Utility Ch 3

 

Disutility

Definition

 

lNegative marginal utility
Term

Measuring Utility Ch 3

 

 

Definition

- Units of utility

    - Each person has a uniquely subjective utility scale-

Ø

- Total utility

Sum of marginal utilities

Term

 CH3

 

ØDeterminants of Demand:
Definition

 

1.Demand is determined by price, prices of other goods, income, and so on.
2.In functional form, a demand function may be expressed as:
3.QX = f( Price of X, Prices of Related Goods, Income, population, Advertising, and so on)
4.Q = a1PX + a2 PR +a3Y + a4POP+ a5i +  a6Q
5.Q = 500PX+ 200PR + 150Y+ 70,000POP –    500,000i+ 700A
Term

 

Market Demand Function
(continued)
ch3
Definition
  • ØMarket demand can be specified for an entire industry or for an individual firm.
  • Ø
  • Ø
  • Ø
  • Demand concepts developed in this chapter apply to both firm and industry demand functions.
    Because firm and industry demand functions differ, different models or equations must be estimated for analyzing these two levels of demand.
    Firms and industry demand functions differ,  because different variables would typically be used in each case.
Term

 

ØIndustry Demand Versus Firm Demand ch3
Definition

 

1.Industry demand is subject to general economic conditions
2.Firm demand is determined by economic conditions and competition.
Term

Basis for Supply

 

Ch 3

Definition

 

ØSupply is a relation showing the various amounts of a commodity that sellers would be willing and able to make available for sale at alternative prices during a given period of time period, all other things remaining the same.
Other Things: Technology, resource costs, taxes and subsidies, price expectation, prices of related goods in production.
Term

 

The Law of Supply
ch3
Definition

 

ØThe quantity supplied of a commodity varies directly with its price, assuming that all other factors that may determine supply remain the same.
Term

Supply curve

 

ch 3

Definition
Relation between price and the quantity supplied, holding all else constant
Term

market supply

ch3

Definition

 

Øis the horizontal summation of the individual supply curves at each price level.
Term

Market supply function

 

ch 3

 

Definition

 

Market supply functions can be specified for an entire industry or for an individual firm.
Term

 

Industry Supply Versus Firm Supply
Definition

 

lIndustry supply is subject to general economic conditions
lFirm Supply is determined by economic conditions and competition.
Term
The Price-quantity Supplied Relation
Definition

 

    • l
    A rise in price will increase the quantity supplied.
  • l
    • A fall in price will decrease the quantity supplied. 
    • A long the supply curve, all non-price variables are held constant

Term

 

Relation Between Supply Curve and Supply Function
Definition

ØMovements Along Supply Curve

lA rise in price causes upward movement along a given supply curve.
lA price decline causes downward movement along a given supply curve.
ØSupply Curve Shifts
lSupply increases if a non-price change allows more to profitably produced and sold.
lSupply decreases if a non-price change causes less to be profitably produced and sold.
Term

 

Market Equilibrium 
ØDemand and Supply Balance
Definition

 

  • l
  • l
  • Equilibrium reflects productive and allocative efficiency.
Equilibrium exists if perfect balance exists in the quantities demanded and supplied.
Term
Market Equilibrium 
 
ØSurplus and Shortage
Definition
  • lSurplus is excess supply.
  • l
  • Shortage is excess demand.
Term

 

Disequilibrium
Definition

ØSurplus

l

- Downward pressure on P

Ø

Shortage

l

- Upward pressure on P

Ø

Disequilibrium

l

- Temporary, or

l

- Result of government intervention

     - Price floors

     - Price ceilings

Term

 

Disequilibrium
Price floors
Definition
  • lSet above equilibrium P
  • l
  • l
  • l
  • l
  • Reduce economic welfare
    Distort markets
    Surplus
    Minimum selling P
Term

 

Disequilibrium
Price Ceilings
Definition
  • Set below the equilibrium P
  • l
  • l
  • l
  • l
  • Reduce economic welfare
    Distort markets
    Shortage
    Maximum selling P
Term

 

Comparative Statics
Definition
  • Study of changing demand and supply conditions

  • lChange continues until a new equilibrium is established.

Term

Comparative Stats

 

Changes in equilibrium

Definition
  • lEquilibrium exists when there is no economic incentive for change in demand or supply.
  • l
  • Changing demand or supply affects equilibrium.
Term

Ch 4

 

Cardinal Utility Theory (the old utility theory)
Definition

 

Øis based on the assumption that inter-comparison of utility is possible.
Term

 

Cardinal Utility Versus Ordinal Utility
Definition
    • Ø
    Using the law of diminishing marginal utility, in the previous session we learned that marginal utility is negatively sloped. This led to the conclusion that demand is negatively sloped.

  • ØUsing cardinal utility we also prove demand is negatively sloped by elaborating on equilibrium condition for utility maximization
Term

 

Utility-Maximizing Conditions
Definition

ØEquilibrium

  • l
  • l
  • l
  • Higher-priced goods must yield more Marginal Utility than lower-price goods
    Last $ spent on each good yields the same marginal utility
There is no way to increase utility by reallocating the budget
Term

 

Ordinal (Modern)Utility Theory
Definition
  • Assumptions About Consumer Preferences
  • l
  • l
  • Ø
  • Utility functions relate well-being to consumption.
    Consumers rank-order desirability of products.
    More is always preferred to less (nonsatiation principles.)
Term

 

Utility function
Definition

is a descriptive statement that relates satisfaction or well-being to the is a descriptive statement that relates satisfaction or well-being to the consumption of goods and services.

ØGeneral form: Utility = f (goods, services)
Term

 

An indifference curve
Definition

- An indifference curve (I) shows all

 combinations of two goods that
 provide a particular consumer  with
 the same total utility. 
- Indifference curve:
 negative slope
- Indifference curves farther from origin depict higher levels of utility.
- A line intersects each higher indifference curve, reflecting more of both goods.
 convex to origin
Term

 

Basic Characteristics of Indifference Curves:
Definition
  • 1.Higher indifference curves are better.
  • 2.
  • 3.
  • 4.
  • Indifference curves are convex to the origin.
    Indifference curves slope downward.
    Indifference curves do not intersect.
Term

 

Indifference curves do not intersect
Definition
Term
Perfect substitues
Definition
goods and services consumed together in the same combination
Term
perfect complements
Definition
goods and services consumed together in the same combination
Term
imperfect substitutes
Definition
reflected in U-Shaped indifference curve
Term

 

Indifference curves and utility maximization
Definition

 

The budget line
  • Combinations of goods

  • Able to buy

  • Consumption possibilities frontier
Term
budget constraint/line
Definition
combo of products that can be purchased for a fixed amount
Term

 

Consumer equilibrium at the tangency
Definition
  • lMaximize utility
  • l
  • Indifference curve tangent to budget line
Term

 

Effects of a change in price
Definition
  • lRelative price change alters budget slope.
  • l
  • Derive the D curve
Term

 

Income and Substitution Effects
Definition
  • lIncome effect changes overall consumption.
  • l
  • Substitution effect alters relative consumption.
Term

 

Effects of Changing Income and Prices
Definition

 

lBudget increase (decrease) causes parallel outward (inward) shift.
Term
Income effect
Definition
increase in overall consumption made possible by a price cute, or decrease in overall consumption that follows a price increase
Term
substitution effect
Definition
change in relative consumption that occurs as consumers substitute cheaper products for more expensive products
Term
price consumption curve
Definition
market baskets that maximize utility at differnet prices for a given item
Term

 

Price-consumption, Income-consumption, and Engle curves
Definition
  • Price-consumption curve shows  consumption impact of price changes.
  • lReflects movement along demand curve.
  • ØInferior good consumption falls with income (rare).Normal good consumption rises with income. Engle curves plot income and consumption. Reflects shift from one demand curve to another.
  • Income-consumption curve shows  consumption impact of income changes.
Term

 

Demand Sensitivity Analysis: Elasticity
Definition
  • ØElasticity measures sensitivity or responsiveness.
  • Ø
  • l
  • Ø
  • l
  • EX = (Y2Y1)/(Y2+Y1) ÷ (X2-X1)/(X2+X1).
    Arc elasticity shows sensitivity of Y to big changes in X.
    εX = ∂Y/Y ÷ ∂X/X.
    Point elasticity shows sensitivity of Y to small changes in X.
Term
income consumption curve
Definition
utility maximizing combinations of goods and services at every income level
Term
engle curve
Definition
a plot of the relationship between income and the quantity consumed of a good or service
Term
normal goods
Definition
goods and services with falling consumption at higher levels of income
Term
Optimal market basket
Definition
best feasible combination of goods and services
Term
revealed preference
Definition
declared choice
Term
marginal rate of substitution
Definition
change in consumption of Y (goods) necessary to offset a given change in the consumption of x (services) if the consumers overall level of utility is to remain constant
Term
consumption path
Definition
optimal combos of products as consumption increases
Term
elasticity
Definition
the % change in a dependent variable, Y, resulting from a 1% change in the value of an independent variable, X
Term
ENDOGENOUS VARIABLES
Definition
factors such as price and advertising that are within the control of the firm
Term
exogenous variables
Definition
factors outside the control of the firm, such as consumer incomes, competitor prices, and the weather
Term
point elasticity
Definition
it measures easticity at a given point on a function
Term
arc elasticity
Definition
avg elasticity over a given range of a function
Term
price elasticity of demand
Definition
responsiveness of quantity demanded to changes in the price of the product itself, holding constant the values of all other variables in the demand function
Term

 

Price Elasticity of Demand
Definition

ØPrice Elasticity Formula

lPoint price elasticity, εP = ∂Q/Q ÷ ∂P/P.
lIn all cases, εP < 0 .
ØPrice Elasticity and Total Revenue
lPrice cut increases revenue if εP> 1.
lRevenue constant if  εP= 1.
lPrice cut decreases revenue if εP< 1.
Term

Price elasticity & total rev

 

elastic demand

Definition
situation in which a price change leads to a more than proportionate change in quantity demanded
Term

price elasticiy and total rev

 

unitary elasticity

Definition
situation in which price and quantity changes exactly offset each other
Term

price elasticity and total rev

inelastic demand

Definition
situation in which a price change leads to a less than proportionate change in quantity demanded
Term

 

Price Elasticity and Marginal Revenue
Definition

 

ØElasticity Varies along Demand Curve
lAs price rises, so too does εP.
lAs price falls, so too doesεP.
ØPrice Elasticity and Price Changes
lMR > 0 if εP> 1.
lMR = 0 if  εP= 1.
lMR < 0 if εP< 1.
Term

 

Price Elasticity and Optimal Pricing Policy
Definition

Optimal Price Formula

lMR and εP are directly related.
lMR = P/[1+(1/ εP)].
lOptimal P* = MC/[1+(1/ εP)].
ØDeterminants of Price Elasticity
lEssential goods have lowεP.
lNonessential goods have highεP
Term
Cross-price elasticity
Definition
responsiveness of demand for one product to changes in the price for another
Term

 

Cross-price Elasticity of Demand
Definition

Cross-price elasticity shows demand sensitivity to changes in other prices.

lεPX = ∂QY/QY ÷ ∂PX/PX.
ØSubstitutes have εPX > 0.
lE.g., Coke demand and Pepsi prices.
ØComplements have εPX < 0.
lE.g., Coke demand and Fritos prices.
ØIndependent goods have εPX = 0.
lE.g., Coke demand and car prices.
Term
income elasticity of demand
Definition
responsiveness of demand to changes in income, holding constant the effect of all other variables
Term

 

Income Elasticity of Demand
Definition

Income elasticity shows demand sensitivity to changes in income.

lεI = ∂Q/Q ÷ ∂I/I.
ØNormal goods have εI > 0.
lNoncyclical normal goods have 0 < εI < 1, e.g., candy.
lCyclical normal goods have εI > 1, e.g., housing.
ØInferior goods have εI < 0.
lVery rare.
Term
countercyclical
Definition
goods fall with rising income, and rise with falling income
Term
noncyclical normal goods
Definition
products for which demand is relatively unaffected by changing income
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