Term
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Definition
ØThe study of the allocation of scarce resources to satisfy human’s alternative wants
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Term
Basic Concepts
The three main functions of management |
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Definition
Planning, Execution, and control |
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Term
Basic Concepts
Managerial economics |
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Definition
is the application of economic theory to solve business problems
-
ØThe techniques learned in managerial economics can also be applied to nonprofit organizations.
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Term
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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.
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Term
Basic Concepts
What is the major difference between microeconomics and macroeconomics? |
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Definition
1.
2.Macroeconomic theory: big picture of the economy.
Microeconomic theory: small picture of the economy. |
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Term
How Is Managerial Economics Useful?
ØEvaluating Choice Alternatives
l
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Definition
Identify ways to efficiently achieve goals.
lSpecify pricing and production strategies.
lSpell out production and marketing rules to maximize profits. |
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Term
How Is Managerial Economics Useful?
Making the best decisions |
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Definition
lManagerial economics helps meet management objectives efficiently.
lManagerial economics shows the logic of consumer, and government decisions.
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Term
| Management decision problems |
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Definition
- Product selection, output, and pricing
- Internet Strategy
- Organization Design
- Product development and promotion strategy
- Worker hiring and training
- Investment and financing
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Term
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Definition
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Term
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Definition
-
Numerical analysis
-
statistical estiamtion
-
forecasting procedures
-
game-theory concepts
-
optimization techniques
-
information systems
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Term
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Definition
The basic model of business enterprise is called the theory of the firm. |
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Term
Theory of Firm
Primary objective |
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Definition
| Long-term expected value maximization |
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Term
Theory of Firm
Value of Firm |
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Definition
| present value of the firm's expected future cash flows |
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Term
Theory of the firm
Present Value |
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Definition
| the value of the expected cash flow discounted back to the present at an appropriate interest rate |
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Term
| The corporation is a legal device |
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Definition
Firm
- investors
- society
- suppliers
- management
- customers
- employees |
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Term
Theory of the Firm
Expected Value Maximization |
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Definition
- owner-mangers maximize short-run profits
- primary goal is longterm expected value maximization
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Term
| Constraints and the theory of the firm |
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Definition
- technology
- resource scarcity
- contractual obligations: work scheduling, work assignemtns
- laws & regulation: minimum wage, health and safety standard, pollution emission standard
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Term
| Limitations of the theory of the firm |
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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
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Term
THE EQUATION FOR THE VALUE OF THE FIRM |
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Definition
Value of the firm = present value of expected future profits
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Term
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Definition
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Term
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Definition
lAll resources have an opportunity cost
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Term
Cost &Profit
Explicit Costs |
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Definition
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Term
Cost & Profit
Implicit Costs
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Definition
- Opportunity costs or resources owned by the firm/firm owners
- No Cash payment |
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Term
Profit Measurement
Business (accounting) profit |
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Definition
Total revenue -- Explicit costs
(minus) |
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Term
Profit Measurement
Economic Profit |
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Definition
Total revenue -- all costs (implicit and explicit)
(minus) |
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Term
Profit measurement
normal profit |
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Definition
lThe business profit just sufficient to ensure all resources used by the firm earn their opportunity costs.
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Term
Profit measurement
Economic Profit |
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Definition
Accounting profit – Normal profit. |
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Term
Profit Measurement
Profit Margin |
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Definition
Ø(Business Profit/Sales) X 100
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Term
Profit Measurement
Return on Stockholder’s Equity (ROE): |
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Definition
Ø(Net Income/(the book value of assets – total liabilities)
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Term
Profit Measurement
ØVariability of Business Profits
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Definition
Business profits vary widely |
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Term
Profit Measurement: Example
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Definition
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Total revenue
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$105,00
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Less explicit costs:
Assistant’s salary
Material and equipment
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$21,000
$20,000
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Equals accounting profit
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$64,000
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Less implicit costs:
Wanda’s forgone salary
Forgone interest on savings
Forgone garage rental
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$50,000
$1,000
$1,200
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Equals economic profit
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$11,800
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Term
Why Do Profits Vary Among Firms?
Disequilibrium Profit Theories
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Definition
l
lUnexpected cost savings
Unexpected revenue growth |
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Term
Why Do Profits Vary Among Firms?
ØCompensatory Profit Theories
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Definition
lProfits accrue to firms that are better, faster, or cheaper than the competition
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Term
Role of Business in Society
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Definition
lBusinesses help satisfy consumer wants.
lBusinesses contributes to social welfare
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Term
Role of Business in Society
Social Responsibility of Business
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Definition
lServe customers
lProvide employment opportunities
lObey laws and regulations
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Term
Business and Social Environment
Technology
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Definition
- Production capacity
- Worker knowledge
- Communications capability
- Research and development |
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Term
Business and Social Environment
Market Environment |
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Definition
Customer Demand
Level of competition
Supplier Capability |
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Term
Business and Social Environment
Legal Environment |
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Definition
Tax burden
Regulatory policy
Trade policy |
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Term
Business and Social Environment
Competitive Strategy |
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Definition
Product choice
Pricing strategy
promotion strategy |
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Term
Business and Social Environment
Organization Design |
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Definition
Assignment of decisions rights
Match worker incentives with managerial motives
Decision management and control |
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Term
|
Definition
|
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Term
|
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 |
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Term
Econ Optimization Ch 2
Overview |
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Definition
ØEconomic Optimization Process
ØRevenue Relations
ØCost Relations
ØProfit Relations
ØIncremental Concept in Economic Analysis
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Term
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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 |
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Term
Economic Optimization Process
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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.
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Term
Functional Relations: Equations |
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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
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Term
Relation Between Total Revenue and Output |
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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
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Term
Revenue Relations
Price and Total Revenue |
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Definition
lTotal Revenue = Price ´ Quantity.
lTR= P ´ Q
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Term
Revenue Relations
Marginal Revenue |
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Definition
lChange in total revenue associated with a one‑unit change in output.
lChanges in the dependent variable caused by a one-unit change in an independent variable.
lMR = ∆TR/ ∆Q
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Term
Revenue Relations
Revenue Maximization |
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Definition
Activity level (or quantity) that generates the highest revenue,
MR = 0 |
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Term
Revenue Relations
Do Firms Really Optimize?
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Definition
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Term
| Relation Between Price and Output |
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Definition
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Term
| Relationship between price, total revenue, marginal revenue and output |
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Definition
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Term
Cost Relations
Total Cost |
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Definition
lTotal Cost = Fixed Cost + Variable Cost.
lTC = TFC + TVC
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Term
Cost Relations
Marginal and Average Cost |
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Definition
lMarginal cost is the change in total cost associated with a one‑unit change in output:
•
lAverage Cost = Total Cost/Quantity
•AC = TC / Q
MC = ∆TC / ∆Q |
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Term
|
Definition
- Average Cost Minimization
Ø
Ø- Average cost is minimized when MC = AC.
Ø- Reflects efficient production of a given output level.
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Term
Profit Relations
Total and Marginal Profit |
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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. |
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Term
Profit Relations
Profit Maximization |
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Definition
lProfit is maximized when Mπ = MR – MC = 0 or MR = MC, assuming profit declines as Q rises.
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Term
Profit Relations
Marginal VS Incremental profits |
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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.
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Term
MARGINALS AS THE DERIVATIVES OF FUNCTIONS |
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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: |
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Term
Changing over the Range of a Curve |
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Definition
|
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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
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Term
Distinguishing Maximum from Minimums |
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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.
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Term
Numerical Example of Max./Min. |
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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.
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Term
Use of Marginals to Maximize the Difference Between Two Functions |
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Definition
|
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Term
| Normal Rate of Return Chapter 1 Definitions |
|
Definition
| Average Profit necessary to attract and retain investment |
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Term
Incremental Concept in Economic Analysis
Incremental Change
CH 2 |
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Definition
| Change resulting from a given managerial decision |
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Term
Incremental Concept in Economic Analysis
Incremental Profit
Ch 2 |
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Definition
| Gain or loss associatied with a given managerial decision |
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Term
Why do profits vary amony firms?
Frictional Profit Theory
Ch 1 |
|
Definition
| Abnormal profits observed following unaticipated changes in demand or cost conditions |
|
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Term
Why do profits vary amony firms?
Monopoly Profit Theory
ch 1 |
|
Definition
| Above- normal profits caused by barriers to entry that limit competition |
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Term
Why do profits vary amony firms?
Innovation Profit Theory
ch 1 |
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Definition
| Above-normal profits that follow sucessful invention or modernization |
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Term
Revenue Relations
Total Revenue
Ch 2 |
|
Definition
|
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Term
Revenue Relations
Dependent Variable
Ch 2
|
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Definition
| Y-Variable determined by x-values |
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Term
Revenue Relations
Independent Variable
Ch 2 |
|
Definition
| X-Variable determined separately from the y-variable |
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Term
Cost Relations
Cost Functions
Ch 2 |
|
Definition
| Relations between cost and output |
|
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Term
Cost Relations
Short-run cost function
Ch 2 |
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Definition
| Cost relations when fixed costs are present; used for day-to-day operating decisions |
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Term
Cost Relations
Long-run cost function
ch 2 |
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Definition
| Cost relation when all costs are variable; used for long-term planning |
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Term
Cost Relations
Short-Run
Ch 2 |
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Definition
| Operating period during which the availability of at least one inpt is fixed |
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Term
Cost Relations
Long Run
Ch 2 |
|
Definition
| Period of complete flexibility with respect to input use |
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Term
Cost Relations
Average Cost Minimization
Ch 2 |
|
Definition
| Activity level that generates the lowest average cost, MC= AC |
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Term
Profit Relations
Total Profit
Ch 2 |
|
Definition
| Difference between total revenue and total cost |
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Term
Profit Relations
Marginal Profit
Ch 2
|
|
Definition
Change in total proftit due to a 1-unit change in output
M(PIE)=MR-MC |
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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 |
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Term
Profit Relations
Break-even points
Ch 2 |
|
Definition
| Output levels with zero profit |
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Term
|
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
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Term
Basis for Demand
Ch 3
Direct Demand
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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.
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Term
Basis for Demand
CH 3
Utility (satisfcation) |
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Definition
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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 |
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Term
Basis for Demand CH 3
Demand Function |
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Definition
| Relation between quantity sold and factors influencing its level |
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Term
Basis for demand
ch 3
Direct Demand |
|
Definition
Øis the demand for products that directly satisfy consumer desires
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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.
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Term
Basis for demand CH 3
Law of demand |
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Definition
The quantity demanded of a commodity varies inversely with its price, assuming that all other factors that may determine demand stay the same |
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Term
Demand curve ch3
Deman curve |
|
Definition
| relation between price and the quantity demanded, holding all else constant |
|
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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
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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 |
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Term
Relation Between the Demand Curve and Demand Function Ch3
ØMovements Along Demand Curve
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|
Definition
lA rise in price causes upward movement along a given demand curve.
lA price decline causes downward movement along a given demand curve.
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Term
Relation Between the Demand Curve and Demand Function
Ch 3
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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.
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Term
Utility Analysis ch 3
Assumption |
|
Definition
lTaste are given
lTastes are relatively stable
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Term
The Law of Diminishing Marginal Utility Ch 3
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Definition
|
|
Term
The Law of Diminishing Marginal Utility Ch 3
Marginal Utility |
|
Definition
lChange in total utility from one-unit change in consumption
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Term
The Law of Diminishing Marginal Utility Ch 3
The more of a good consumed |
|
Definition
The smaller the increase in total utility |
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Term
The Law of Diminishing Marginal Utility Ch 3
ØMarginal utility from each additional unit
|
|
Definition
lDeclines as more is consumed
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Term
The Law of Diminishing Marginal Utility Ch 3
Disutility |
|
Definition
lNegative marginal utility
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|
Term
|
Definition
- Units of utility
- Each person has a uniquely subjective utility scale-
Ø
- Total utility
Sum of marginal utilities |
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Term
|
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
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Term
Market Demand Function
(continued)
ch3 |
|
Definition
|
|
Term
ØIndustry Demand Versus Firm Demand ch3
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|
Definition
1.Industry demand is subject to general economic conditions
2.Firm demand is determined by economic conditions and competition.
|
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Term
|
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.
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Term
|
Definition
ØThe quantity supplied of a commodity varies directly with its price, assuming that all other factors that may determine supply remain the same.
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Term
|
Definition
| Relation between price and the quantity supplied, holding all else constant |
|
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Term
|
Definition
Øis the horizontal summation of the individual supply curves at each price level.
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Term
Market supply function
ch 3
|
|
Definition
Market supply functions can be specified for an entire industry or for an individual firm. |
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Term
Industry Supply Versus Firm Supply |
|
Definition
lIndustry supply is subject to general economic conditions
lFirm Supply is determined by economic conditions and competition.
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Term
| The Price-quantity Supplied Relation |
|
Definition
-
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
|
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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.
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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
|
Definition
|
|
Term
|
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
|
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|
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
|
|
Term
|
Definition
-
Study of changing demand and supply conditions
-
lChange continues until a new equilibrium is established.
|
|
|
Term
Comparative Stats
Changes in equilibrium |
|
Definition
|
|
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
|
|
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
|
|
Term
|
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
|
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
|
|
Term
Indifference curves do not intersect
|
|
Definition
|
|
Term
|
Definition
| goods and services consumed together in the same combination |
|
|
Term
|
Definition
| goods and services consumed together in the same combination |
|
|
Term
|
Definition
| reflected in U-Shaped indifference curve |
|
|
Term
Indifference curves and utility maximization |
|
Definition
The budget line
-
-
Able to buy
-
Consumption possibilities frontier
|
|
|
Term
|
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
|
|
Term
Income and Substitution Effects |
|
Definition
|
|
Term
Effects of Changing Income and Prices
|
|
Definition
lBudget increase (decrease) causes parallel outward (inward) shift.
|
|
|
Term
|
Definition
| increase in overall consumption made possible by a price cute, or decrease in overall consumption that follows a price increase |
|
|
Term
|
Definition
| change in relative consumption that occurs as consumers substitute cheaper products for more expensive products |
|
|
Term
|
Definition
| market baskets that maximize utility at differnet prices for a given item |
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Term
Price-consumption, Income-consumption, and Engle curves |
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Definition
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Term
Demand Sensitivity Analysis: Elasticity |
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Definition
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Term
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Definition
| utility maximizing combinations of goods and services at every income level |
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Definition
| a plot of the relationship between income and the quantity consumed of a good or service |
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Definition
| goods and services with falling consumption at higher levels of income |
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Definition
| best feasible combination of goods and services |
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Term
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Definition
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Term
| marginal rate of substitution |
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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 |
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Definition
| optimal combos of products as consumption increases |
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Definition
| the % change in a dependent variable, Y, resulting from a 1% change in the value of an independent variable, X |
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Definition
| factors such as price and advertising that are within the control of the firm |
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Definition
| factors outside the control of the firm, such as consumer incomes, competitor prices, and the weather |
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Term
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Definition
| it measures easticity at a given point on a function |
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Term
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Definition
| avg elasticity over a given range of a function |
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Term
| price elasticity of demand |
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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 |
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Term
Price Elasticity of Demand |
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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.
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Term
Price elasticity & total rev
elastic demand |
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Definition
| situation in which a price change leads to a more than proportionate change in quantity demanded |
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Term
price elasticiy and total rev
unitary elasticity |
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Definition
| situation in which price and quantity changes exactly offset each other |
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Term
price elasticity and total rev
inelastic demand |
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Definition
| situation in which a price change leads to a less than proportionate change in quantity demanded |
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Term
Price Elasticity and Marginal Revenue |
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Definition
ØElasticity Varies along Demand Curve
lAs price rises, so too does │εP│.
lAs price falls, so too does│εP│.
ØPrice Elasticity and Price Changes
lMR > 0 if │εP│> 1.
lMR = 0 if │εP│= 1.
lMR < 0 if │εP│< 1.
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Term
Price Elasticity and Optimal Pricing Policy |
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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 low│εP│.
lNonessential goods have high│εP│
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Term
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Definition
| responsiveness of demand for one product to changes in the price for another |
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Term
Cross-price Elasticity of Demand |
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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.
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Term
| income elasticity of demand |
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Definition
| responsiveness of demand to changes in income, holding constant the effect of all other variables |
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Term
Income Elasticity of Demand |
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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.
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Term
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Definition
| goods fall with rising income, and rise with falling income |
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Term
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Definition
| products for which demand is relatively unaffected by changing income |
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