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Reading 14: Topics in Demands and Supply Analysis (Normal vs. Inferior…
Reading 14: Topics in Demands and Supply Analysis
Elasticity
Own Price Elasticity
Formula: \(E_{OwnPrice}=\frac{\%\Delta Q_{demanded}}{\%\Delta P_{Own}}\)
Own Price Elasticity > 1: Demand is elastic
Own Price Elasticity <1: Demand is inelastic
Cross Price Elasticity
Formula: \(E_{CrossPrice}=\frac{\%\Delta Q_{demanded}}{\%\Delta P_{RelatedGood}}\)
Cross Price Elasticity > 0: Related goods is a substitute
Cross Price Elasticity < 0: Related goods is a complement
Income Elasticity
Formula: \(E_{Income}=\frac{\%\Delta Q_{demanded}}{\%\Delta Income}\)
Income Elasticity > 0: Normal goods
Income Elasticity < 0: Inferior goods
Substitution and Income Effect
Substitution effect
: When price of good A decreases, consumer spend more on good A, and less on others
Income effect
: When price of good A decreases, for the same goods combo consumer will have additional unspent income, which will have an effect on total consumption.
Normal vs. Inferior Goods
Normal Goods
: Positive income effect (of a price decrease); Income elasticity > 0
Inferior Goods
: Negative Income effect (of a price decrease); income elasticity < 0
Increase in income reduces the demand for inferior goods.
Giffen Goods
: an inferior good, for which(in a price decrease) the negative income effect > positive substitution effect.
--> A decrease (increase) in good price cause a decrease (increase) in quantity demanded
Veblen Goods
: NOT INFERIOR GOODS.
An increase (decrease) in price cause an increase (decrease) in quantity demanded.
Diminishing Marginal Return
Increasing one factor of production input while holding others will increase the marginal return, however only until a point beyond which marginal return will decrease.
Breakeven & Shutdown points of Production
Under perfect competition
Breakeven quantity of production
: is quantity for which:
Price (P) = Average Total Cost (ATC), and
Total revenue (TR) = Total Cost (TC)
Long-run shutdown quantity
when P < ATC and thus TR < TC
Short-run shutdown quantity
when
P < Average Variable Cost (AVC), and thus
TR < Total Variable Cost (TVC)
Under imperfect competition
Firms face downward-sloping demand
Breakeven quantity
: quantity for which TR=TC
Long-run shutdown
if TR < TC
Short-run shutdown
if TR < TVC
Economies of Scale
Economies of Scale
: indicated by the downward-sloping segment of LRATC, where increasing production reduce average total cost.
Diseconomies of Scales
: indicated by the upward-sloping segment of LRATC, where increasing production quantity will increase average total cost.
Long-run average total cost (LRATC) curve
shows the minimum average total cost fo each level of output.