Topics in Demand and Supply Analysis

Question 1

What is own price elasticity?

Answer 1

Own-price elasticity is a measure of the responsiveness of the quantity demanded to a change in price.

Question 2

How is own price of elasticity calculated?

Answer 2

Question 3

When is own price elasticity of demand elastic? When is it inelastic?

Answer 3

|own-price elasticity| > 1: demand is elastic (
|own-price elasticity| < 1: demand is inelastic

Question 4

Price Elasticity Along a Linear Demand Curve?

Answer 4

Question 5

What is cross price elasticity of demand?

Answer 5

The ratio of the percentage change in the quantity demanded of a good to the percentage change in the price of a related good.

Question 6

How to calculate cross price elasticity of demand?

Answer 6

Question 7

What is a substitute?

Answer 7

When an increase in the price of a related good increases demand for a good, the two goods are substitutes.
cross-price elasticity > 0: related good is a substitute

Question 8

What is a complement?

Answer 8

When an increase in the price of a related good decreases demand for a good.
cross-price elasticity < 0: related good is a complement

Question 9

What is income elasticity of demand?

Answer 9

The sensitivity of quantity demanded to a change in income.

Question 10

How to calculate income elasticity of demand?

Answer 10

Question 11

What is an inferior good?

Answer 11

The case that an increase in income leads to a decrease in quantity demanded
income elasticity < 0: good is an inferior good

Question 12

What is a normal good?

Answer 12

The case that an increase in income leads to a decrease in quantity demanded.
income elasticity > 0: good is a normal good

Question 13

What is the substitution effect?

Answer 13

The substitution effect refers to the change in demand for a good as a result of a change in the relative price of the good compared to that of other substitute goods.
When the price of Good X decreases, there is a substitution effect that shifts consumption towards more of Good X.

Question 14

What is the income effect?

Answer 14

The resulting change in demand for a good or service caused by an increase or decrease in a consumer’s purchasing power or real income. (Can be toward more or less consumption)
The total expenditure on the consumer’s original bundle of goods falls when the price of Good X falls.

Question 15

What are the three possible outcomes of a decrease in price x?

Answer 15

1) The substitution effect is positive, and the income effect is also positive—consumption of Good X will increase.
2) The substitution effect is positive, and the income effect is negative but smaller than the substitution effect—consumption of Good X will increase.
3) The substitution effect is positive, and the income effect is negative and larger than the substitution effect—consumption of Good X will decrease.

Question 16

What is a Giffen good?

Answer 16

A Giffen good is an inferior good for which the negative income effect outweighs the positive substitution effect when price falls. A Giffen good is theoretical and would have an upward-sloping demand curve. At lower prices, a smaller quantity would be demanded as a result of the dominance of the income effect over the substitution effect.

Question 17

What is a Veblen good?

Answer 17

A Veblen good is one for which a higher price makes the good more desirable. The idea is that the consumer gets utility from being seen to consume a good that has high status (e.g., Gucci bag), and that a higher price for the good conveys more status and increases its utility. Such a good could conceivably have a positively sloped demand curve for some individuals over some range of prices.

Question 18

What is diminishing marginal productivity?

Answer 18

When we reach the quantity of labor for which the additional output for each additional worker begins to decline

Question 19

What are diminishing marginal returns?

Answer 19

Predicts that after some optimal level of capacity is reached, adding an additional factor of production will actually result in smaller increases in output.

Question 20

Graph for production Function (Capital Fixed, Labor Variable)

Answer 20

Question 21

What happens when Average Revenue < Average Variable Cost? (Perfect Comp)

Answer 21

Shutdown point in the short run and exit point in the long run.

Question 22

What happens when Average Revenue > Average Variable Cost? (Perfect Comp)

Answer 22

The firm should stay open in the short run but exit in the long run

Question 23

What happens when Average Revenue > Average Total Cost? (Perfect Comp)

Answer 23

The firm should stay in the market in both the short and long run.

Question 24

Shutdown and Breakeven Graph in Perfect Competition

Answer 24

Question 25

Why do we use total cost and total revenue in market under imperfect competition?

Answer 25

Because marginal revenue is no longer equal to price.

Question 26

What happens when Total Revenue = Total Cost? (Imperfect Comp)

Answer 26

Break Even

Question 27

What happens when Total Cost>Total Revenue>Total Variable Cost? (Imperfect Comp)

Answer 27

Firm should continue to operate in the short run but shut down in the long run.

Question 28

What happens when Total Revenue

Answer 28

Firm should shut down in the short run and the long run.

Question 29

Breakeven Point Using the Total Revenue/Total Cost Approach Graph

Answer 29

Question 30

Economies and Diseconomies of Scale Graph

Answer 30

The lowest point on the LRATC corresponds to the scale or plant size at which the average total cost of production is at a minimum. This scale is sometimes called the minimum efficient scale. Under perfect competition, firms must operate at minimum efficient scale in long-run equilibrium, and LRATC will equal the market price.

Question 31

What are Economies of scale? and what causes them?

Answer 31

Increasing returns to scale Causes: Labor specialization Mass production Investment in more efficient equipment and technology. May be able to negotiate lower input prices with suppliers as firm size increases and more resources are purchased. -A firm operating with economies of scale can increase its competitiveness by expanding production and reducing costs.

Question 32

What are Diseconomies of scale? and what causes them?

Answer 32

Happen when a company or business grows so large that the costs per unit increase. Causes: Increasing bureaucracy of larger firms leads to inefficiency Problems with motivating a larger workforce, and greater barriers to innovation and entrepreneurial activity. -A firm operating under diseconomies of scale will want to decrease output and move back toward the minimum efficient scale.