Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Lecture 2 Elasticity Costs Perfect Competition Elasticity • Elasticity is a measure of how responsive the quantity demanded is to changes in environmental variables that determine demand. • To make the measure units free, elasticity is calculated as the % change in quantity demanded per % change in a variable. Own Price Elasticity • For own price elasticity, the variable is product price. • Own price elasticity is: % change in quantity demanded of X / % change in price of X. • Own price elasticity is negative; demand is referred to as elastic if elasticity is greater than 1 (in absolute value), inelastic if it is less than 1 (in absolute value) and unitary elastic if elasticity equals -1. Sales Revenue and Elasticity • Why care about own price elasticity? • If demand is elastic, then a price reduction increases sales revenue; if demand is inelastic, then a price rise leads to an increase in sales revenue. Cross Price Elasticity • Cross price elasticity measures how responsive quantity demanded is to changes in price of other goods. • Cross price elasticity is: % change in quantity demanded of X / % change in price of Y. • Often used to measure whether or not two goods are in same market Income Elasticity • Income elasticity measures how responsive quantity demanded is to changes in income. • Income elasticity is: % change in quantity demanded of X / % change in income. • If positive—normal good • If negative—inferior good Elasticity of Supply • Elasticity of supply measures how responsive quantity supplied is to changes in its price. • Elasticity of supply is: % change in quantity supplied of X / % change in price of X. The Cost Function • As the demand function summarizes the customer/sales side of the market, the cost function summarizes the production side of the market. • What should costs depend on? – input prices (including price of raising capital) – quantity produced – Technology Cost Function Cont’d • Cost function properties: – Cost increasing in quantity produced – Cost increasing in input prices – Cost decreasing for technology improvements. • Cost can be divided into two components: a fixed cost component (F) and a variable cost component (c(x)). Marginal and Average Cost • Average cost gives cost per unit: C / x • Since price gives revenue per unit, price relative to average cost determines if profits positive or negative • Marginal cost gives the increase in costs due to an increase in quantity produced. Formally, marginal cost is the slope of the variable cost function. The Marginal Cost Function • The amount by which costs increase as quantity produced increases (i.e., marginal cost) may or may not vary with output • We consider two cases: – constant marginal cost: c(x) = cx – increasing marginal cost • The latter is typically viewed as the result of some input being in fixed supply The Average Cost Function • Average cost also varies with quantity produced: AC = C / x • The way that average cost varies with x is determined by the way that marginal cost varies: – if c(x) = cx, then AC = F / x + c and so AC declining with x if F > 0 and constant if F = 0 – If c(x) increasing, then AC = F / x + c(x) / x. AC is U – shaped if F > 0, increasing if F = 0 Market Structures Perfect Competition • • • • • Large numbers of “small” producers Identical product All firms are “price takers” Free entry into and exit from market Perfect information Perfect Competition Cont’d • Choose output such that PX = MC(x) • Firm supply curve is that part of MC curve above AC. Market supply curve is sum of firm supply curves • Entry/exit occurs until profits 0: PX = minX AC(x)