Economics Key Concepts: Opportunity, Demand, and Elasticity
Key Economic Concepts
Opportunity Cost
Opportunity Cost – Value of the next best alternative (ratio of goods where the cost is the second good in the denominator).
Absolute Advantage
Absolute Advantage – Can produce more with fewer resources or in the same time.
Comparative Advantage
Comparative Advantage – Lower opportunity cost for a good.
Maximum Willingness to Trade
- Write a country’s ratio with the desired item in the denominator.
- Multiply by the amount of the desired product.
Minimum Willingness to Give
- Dimensional analysis converting item –> time.
- Determine how many of the desired items can be made in that time.
PPF Intercepts
PPF Intercepts – Put all hours into the x/y axis good.
PPF Slope
PPF Slope – Negative opportunity cost of the x-axis good.
CPF Intercepts
CPF Intercepts – Change comparative advantage good to the other using TOT (Terms of Trade).
Demand and Supply
Demand (D) – Relationship between price and quantity demanded (Price at a quantity is WTP – Willingness to Pay): P up/ QD down, P down/ QD up
Supply (S) – Relationship between price and quantity supplied (S = MC – Marginal Cost). **MOVEMENT R/L FOR S/D IS INC/DEC (Increase/Decrease)**
Related Goods
Complimentary Good – Price of one Increases/Decreases demand of the other Decreases/Increases.
Substitute Good – Price of a good Increases/Decreases demand of the other.
Inferior and Normal Goods
Inferior Good – Income Increases, Demand Decreases. **An Increase/Decrease in consumer expectations about future prices causes an Increase/Decrease in demand today** D down, P down, Q down
Normal Good – Income Increases, Demand Increases. ** # Consumers Increase, Demand Increases.
Factors Affecting Demand
Factors affecting demand – Income, number of consumers, expectations of future prices, prices of related goods.
Consumer Surplus
Consumer Surplus (CS) – WTP – P (Graphically bounded above by D and below by P, on the side by a line up from quantity).
Profit and Revenue
Profit – Revenue – Cost
Revenue – P * Q
Marginal Analysis
Marginal Revenue (MR) – Additional revenue from selling one more unit (2x as steep as demand, same y-int, x-int is 1/2 Demand x-int)
Marginal Cost (MC) – Additional cost incurred by a firm for producing one more unit.
Profit Maximization
Profit Maximizing Price (P) – Price where MC = MR ** Deals with lowering cost (firms): ΔMC
Producer Surplus (PS) – P – MC (Graphically bounded above by price and below by marginal cost). ** Deals with changing prices (Consumer attitudes): ΔD
| Shifts (Market power) | |
|---|---|
| D —> | P up/Q up |
| D <— | P down/Q down |
| MC UP | P up/Q down |
| MC DOWN | P down/Q up |
Perfect Competition
A firm in P.C. (Perfect Competition) – Horizontal demand equal to MC/S
Factors Affecting Supply
Factors affecting Supply – MC shifters, Tech, # sellers, Expectations, Prices of substitutes and complements
Equilibrium
Equilibrium – EQ Price/Quantity located where Qd = Qs
Total and Deadweight Surplus
Total Surplus (TS) = CS + PS
DWL (Deadweight Loss) – Reduction in total surplus from market inefficiency
| Shifts in P.C | Predictions |
|---|---|
| D —> | P up/Q up |
| D <— | P down/Q down |
| S <— | P up/Q down |
| S —> | P down/Q up |
Elasticity of Demand
Own Price Elasticity of Demand – E^D = (%ΔQ^D)/(%ΔP) **Measure of consumer responsiveness to Δprice %Δ = (x2 -x1)/(x1) * 100
Abs. value of E^D > 1 D is elastic, Abs. value of E^D < 1 D is inelastic, Abs. value of E^D = 1 D is unit elastic
More elastic – Bigger quantity response to change in demand, MORE HORIZONTAL MORE ELASTIC
Different regions of elasticity – Top half of demand (Elastic), Lower half (inelastic)
- Firm in inelastic region should increase prices
- Firm in elastic region’s actions depends
| Elasticities (characteristics) | D more elastic if |
|---|---|
| Necessity | Less necessary |
| Availability of substitutes | more substitutes |
| Market definition | More narrow |
| Time horizon | longer |
Income Elasticity of Demand
Income Elasticity of demand – IE^D = (%ΔQ^D)/(%ΔI). **Measures consumer responsiveness to a change in income**
IE^D < 0 inferior, IE^D = 0 no relationship, IE^D > 0 normal good
Cross Price Elasticity of Demand
Cross Price Elasticity of demand – XE^D = (%ΔQ^D good A)/(%ΔP good B) ** Measures responsiveness to change in price of another good
XE^D > 0 Sensitive, XE^D = 0 No relation, XE^D < 0 compliments
Elasticity of Supply
Own Price Elasticity of Supply – E^S = (%ΔQ^S)/(%ΔP) ** Measures producers responsiveness to change in a good’s price
| Determinates of supply elasticity | More elastic if |
|---|---|
| Time horizon | Longer horizon |
| Production constraint; | |
| -Production time | shorter production time |
| -Perishability | Less perishable |
| -Capital requirements | Less capital required |