Econ 101

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A consumer’s willingness to pay for a good

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is the maximum price at which he or she would buy that good.

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Individual consumer surplus

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is the net gain to an individual buyer from the purchase of a good. It is equal to the difference between the buyer’s willingness to pay and the price paid.

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Total consumer surplus

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is the sum of the individual consumer surpluses of all the buyers of a good.

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consumer surplus

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is often used to refer to both individual and total consumer surplus.

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The total consumer surplus generated by purchases of a good at a given price is

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equal to the area below the demand curve but above that price.

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A fall in the price of a good increases consumer surplus through two channels

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A gain to consumers who would have bought at the original price and
A gain to consumers who are persuaded to buy by the lower price.

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A potential seller’s cost

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is the lowest price at which he or she is willing to sell a good.

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Individual producer surplus

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is the net gain to a seller from selling a good. It is equal to the difference between the price received and the seller’s cost.

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Total producer surplus in a market

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is the sum of the individual producer surpluses of all the sellers of a good. The total producer surplus from sales of a good at a given price is the area above the supply curve but below that price.

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When the price of a good rises, producer surplus increases through two channels

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The gains of those who would have supplied the good even at the original, lower price and
The gains of those who are induced to supply the good by the higher price.

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total surplus

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generated in a market is the total net gain to consumers and producers from trading in the market. It is the sum of the producer and the consumer surplus.

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there are gains from trade

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The previous graph shows that both consumers and producers are better off because there is a market in this good, the reason everyone is better off participating in a market economy than they would be if each individual tried to be self-sufficient.

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Reason 1. Market Equilibrium Maximizes Total Surplus

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1. It allocates consumption of the good to the potential buyers who value it the most, as indicated by the fact that they have the highest willingness to pay.

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Reason 2. Market Equilibrium Maximizes Total Surplus

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2. It allocates sales to the potential sellers who most value the right to sell the good, as indicated by the fact that they have the lowest cost.

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Reason 3. Market Equilibrium Maximizes Total Surplus

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3. It ensures that every consumer who makes a purchase values the good more than every seller who makes a sale, so that all transactions are mutually beneficial.

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Reason 4. Market Equilibrium Maximizes Total Surplus

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4. It ensures that every potential buyer who doesn’t make a purchase values the good less than every potential seller who doesn’t make a sale, so that no mutually beneficial transactions are missed.

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midpoint method

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is a technique for calculating the percent change. In this approach, we calculate changes in a variable compared with the average, or midpoint, of the starting and final values.

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Why Does It Matter Whether Demand is Unit-Elastic, Inelastic, or Elastic?

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Because this classification predicts how changes in the price of a good will affect the total revenue earned by producers from the sale of that good.

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The total revenue

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is defined as the total value of sales of a good or service. Total Revenue = Price × Quantity Sold

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Price increase
two countervailing effects in action (except in the rare case of a good with perfectly elastic or perfectly inelastic demand):

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A price effect: After a price increase, each unit sold sells at a higher price  which tends to raise revenue.

A quantity effect: After a price increase, fewer units are sold  which tends to lower revenue.

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If demand is elastic...

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the quantity effect is stronger than the price effect.
an increase in price reduces total revenue.

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If demand is inelastic...

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the price effect is stronger than the quantity effect.
a higher price increases total revenue.

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If demand is unit-elastic...

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the sales effect and the price effect exactly offset each other.
an increase in price does not change total revenue.

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What Factors Determine the Price Elasticity of Demand?

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Whether Close Substitutes Are Available

Whether the Good Is a Necessity or a Luxury

Share of Income Spent on the Good

Time: long-run versus short-run:
The price elasticity of demand is likely to be higher in the long run than in the short run.

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The cross-price elasticity of demand between two goods measures

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the effect of the change in one good’s price on the quantity demanded of the other good.
Positive for substitutes.
Negative for complements.

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The income elasticity of demand

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is the percent change in the quantity of a good demanded when a consumer’s income changes divided by the percent change in the consumer’s income.

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Positive for a normal good

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- the quantity demanded at any given price increases as income increases.

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Negative for an inferior good

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- the quantity demanded at any given price decreases as income increases.

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The price elasticity of supply is a measure

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of the responsiveness of the quantity of a good supplied to the price of that good
It is the ratio of the percent change in the quantity supplied to the percent change in the price as we move along the supply curve.

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Perfectly inelastic supply-- when the price elasticity of supply is zero

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changes in the price of the good have no effect on the quantity supplied.
A perfectly inelastic supply curve is a vertical line.

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Perfectly elastic supply when even a tiny increase or reduction in the price will lead to very large changes in the quantity supplied

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the price elasticity of supply is infinite.
A perfectly elastic supply curve is a horizontal line.

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What Factors Determine the Price Elasticity of Supply?

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The Availability of Inputs:
It tends to be large when inputs are readily available and can be shifted into and out of production at a relatively low cost.
It tends to be small when inputs are difficult to obtain.

Time:
Long-run price elasticity of supply is often higher than the short-run elasticity.
Producers have more time to respond to a price change in the long-run.

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The price elasticity of demand

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is the ratio of the percent change in the quantity demanded to the percent change in the price
as we move along the demand curve (dropping the minus sign).

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Demand is unit-elastic

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if the price elasticity of demand is exactly 1.
1% increase in price  1% decrease in quantity demanded .

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Demand is elastic

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if the price elasticity of demand is greater than 1.
1% increase in price  More than 1% decrease in quantity demanded .

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Demand is inelastic

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if the price elasticity of demand is less than 1.
1% increase in price  Less than 1% decrease in quantity demanded .

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Two Extreme Cases of Price Elasticity of Demand:

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Demand is perfectly inelastic:
the quantity demanded does not respond at all to changes in the price.

Demand is perfectly elastic:
any price increase will cause the quantity demanded to drop to zero.

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When demand is perfectly inelastic, the demand curve is...

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a vertical line.

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When demand is perfectly elastic, the demand curve is...

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a horizontal line.

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Why Does It Matter Whether Demand is Unit-Elastic, Inelastic, or Elastic?

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Because this classification predicts how changes in the price of a good will affect the total revenue earned by producers from the sale of that good.

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The utility of a consumer is

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a measure of the satisfaction the consumer derives from consumption of goods and services.
An individual’s consumption bundle is the collection of all the goods and services consumed by that individual.

The unit of utility is a util.

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The marginal utility curve

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of a good or service is the change in total utility generated by consuming one additional unit of that good or service.

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The principle of diminishing marginal utility says...

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says that each successive unit of a good or service consumed adds less to total utility than the previous unit.

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A budget constraint

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requires that the cost of a consumer’s consumption bundle be no more than the consumer’s total income.

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A consumer’s budget line shows

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the consumption bundles available to a consumer who spends all of his or her income.

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The optimal consumption bundle

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is the consumption bundle that maximizes a consumer’s total utility given his or her budget constraint.

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Indifference curves

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A contour line that maps consumption bundles yielding the same amount of total utility is known as an indifference curve. They represent a consumer’s utility function.

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The entire utility function of an individual can be represented by an indifference curve map

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, a collection of indifference curves in which each curve corresponds to a different total utility level.

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All indifference curve maps share two general properties:

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indifference curves never cross.
the farther out an indifference curve is from the origin, the higher the level of total utility it indicates.

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Indifference Curve

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indifference curves never cross.
the farther out an indifference curve is from the origin, the higher the level of total utility it indicates.

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We will use indifference curve maps...

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to find the utility-maximizing consumption bundle of a consumer given his/her budget constraint.

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The optimal consumption bundle

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is the consumption bundle that maximizes a consumer’s total utility given his or her budget constraint.

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The tangency condition between the indifference curve and the budget line

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holds when the indifference curve and the budget line just touch. This condition determines the optimal consumption bundle when the indifference curves have the typical convex shape.