elasticity (price of demand)= P(dQ)/Q(dP) complete inelastic, consumers will buy good regardless of price (vertical line) infinitely

elastic, consumers will buy as much of a good at a price, anything hi gher D=0, any thing lower D=infinity (horizontal line) income elasticity of demand I/Q (dQ/dI) cross price elasticity= dQb/dPm (Qb/Pm)= P,m/Q,b(dQ,b/dP,m) inelastic if |E|<1 unit elastic |E|=1 elastic |E|>1 nominal price= absolute price not inflation adjusted real price= good price relative to aggregate measure of prices adjusted for inf lation most good income elasticity is greater in the long run opposite for a durable good ==== preferences: completeness, transitivity, more is better than less, *diminishing MRS market basket, indifference curve, indifference map marginal rate of substitution= maximum amount of a good that a consumer is willi ng to give up for one additional unit of another good diminishing MRS= most indifference curves are bowed inward, as more of a good is given up, the consumer will need more of the other good to give the decreasing one up perfect substitutes= two goods whose MRS for each other is constant perfect compliments= two goods whose MRS for each other are either 0 or infinity (form right angles bads, utility, utility map, utility function ordinal utility function: ranks baskets in order of preferance cardinal : describes how much one basket is worth to one another budget constraints, budget line assumption: consumers maximize their satisfaction maximizing basket must: be on the budget line.2. give the consumer the most pref erred combination of goods maximized at MRS=Pf/Pc marginal benefit, marginal cost corner solution: situation in which mrs is not equal to slope of budget line revealed preference, marginal utility, diminishing marginal utility equal marginal principle= utility is maximized when consumer has equalized MU$ o f expenditure across all goods MUf/Pf=MUc/Pc =======

price consumption curve= curve tracing the utility maximizing combination of two goods as the price of one changes individual demand curve= level of utility that can be attained changes as we mov e along curve; at every point of curve consumer is maximizing utility by satisfy ing MRS of x/y= $x/$y income consumption curve= curve tracing utility maximizing combination of two go ods as consumer's income changes normal/inferior goods engel curve: normal goods have a positive slope engel curve, inferior goods have a negative slope engel curve substitutes, compliments, independents fall in price of a good has 2 effects: buy more of cheaper good, less of expens ive one- substitution effect because one good is cheaper consumers en joy an increase in purchasing power, change in demand is due to change in real purchasing power- income effect total effect= substitution+income giffen good= demand slopes upward because the negative income effect is greater than the substitution effect market demand curve: market demand will shift to right as more consumers ente r the market; factors that influence demand of many consumers with affect market demand isoelastic demand curve: demand curve with constant price elasticity speculative demand: change in demand driven by expectation of price change consumer surplus: difference what consumer is willing to pay and the amount paid network externality: when each individuals demand depends on the purchases of ot her individuals bandwagon effect: positive network externality snob effect: negative network externality ===== theory of firm production decision depend on: production technology, cost constraints, input ch oices firms exist because of: coordination, reduced transaction costs factors of production: labor, materials, capital short run, long run, fixed input, average product, marginal product average product: q/L marginal product: dq/dL MP>AP then AP increases law of diminishing marginal returns, technilogical change, stock of capital labor productivity:average product of labor for an entire industry or the econom y as a whole one of most important sources of labor productivity growth is stock of capital isoquants: curve showing all possible combinations that yield same output (PRODU CTION INDIFFERENCE) input flexibility marginal rate of technical substitution: amount by which quantity of one input c an be reduced when one extra unit of another input is used so output is const ant -dK/dL for fixed q

fixed proportion production functions: production function with L isoquants beca use only one combination of labor and capital can be used (perfect compliments aka 1 man 1 machine) production function of perfect substitutes: isoquants straight lines (MRTS is co nstant, labor and capital can be substituted for each other) returns to scale:rate at which output increases as inputs are increased proporti onally increasing returns to scale, constant, decreasing ================== accounting cost: actual expenses plus depreciation charge for economic cost: cost to a firm of utilizing economic resources opportunity cost, sunk cost, total cost, fixed cost, variable amortization: policy of treating a one time expenditure as an out over some years

capital equipment in production cost annual cost spread

marginal cost, average total cost, average fixed cost, average variable cost short run MC dVC=w dL MC=d VC/dQ extra labor for one more output is dL/dQ=1/MP,L MC=w/MP,L

MC cross AVC and ATC at their minimums user cost of capital: annual cost of owning and using a capital asset; equal to depreciation plus forgone interest rental rate of capital; if capital market is competative rental rate= user cost, r isocost line:(budget curve of production) C=wL+rK K= C/r - w/r (L) slope= dK/dL= -w/r MRTS= -dK/dL (negative slope) w/r minimizing cost of a particular output MP,L/w=MP,K/r expansion path: curve passing through points of tangency between isocost line an d isoquant slope= dK/dL move from expansion to cost curve: 1. choose output level of isoquant, find tangent 2. from isocost, determine minimum cost of production level 3. graph output cost combination

short run expansion is horizontal long run is more sloped 45 deg-ish in the long run the ability to change the amount of capital allows firm to reduc e cost most important determinant of shape of long run average and marginal curves is t he relationships between the scale of the firms operation and the inputs that ar e required to minimize its costs long run average cost curve (LAC): curve relating average cost of production to output when all input is variable as output increases average cost will decrease to a point 1.larger firm, more specialization of workers, aka more productive 2. flexible scale, varying input combinations production can be efficient 3. firm may be able to acquire bulk pricing (lower) and reduce input costs average cost will rise: 1. in short run factory space and machinery limit production 2. managing a larger firm may become more complex and inefficient as number of t asks increase 3. buying in bulk may stop lowering prices, as input supplies limited thus raisi ng their costs economies of scale: output doubled when input < doubled diseconomies of scale: output doubled input> doubled cost output elasticity production transformation curve: curve showing various combinations of two outpu ts that can be produced with given inputs economies of scope: situation when joint output of a single firm is greater than output of two different firms producing a single product diseconomies of scope: opposite degree of economies of scope: percent of cost savings when two or more products are produced jointly rather than individually SC= [Cq1+Cq2-Cq1q2]/Cq1q2 ============================== perfectly competitive price taker: FIRM has no influence on market, takes prices as given product homogeneity free entry (exit) highly elastic demand curves, relative ease of entry profit: difference of revenue and cost marginal revenue MC=P=MR output rule if a firm is producing any output it should produce at level where M R=MC

producer surplus: sum over all units in which differences between price and MC

PS=R-VC profit=R-VC-FC =R-wL-rK zero economic profit a firm is earning a normal return on its investment long run competitive equilibrium 1. all firms maximizing profit 2. no entry or exit because all firms earning zero economic profit 3. price of product is such that Q,d=Q,s economic rent: amount firms are willing to pay for an input LESS than minimum ne cessary to obtain it tax= MC2=MC1+t AVC2=AVC1+t S2=S1+t ===== MRS=P,x/P,x=MU,x/MU,y MU,x= dU/dx MU,y= dU/dy