Chapter 4 - Elasticity

Price elasticity of demand: percentage change in quantity from a 1 percent change in price
% change in Q / % change in P
ed = P/Q x 1/slope
Elastic demand: price elasticity is greater than 1
Inelastic demand: price elasticity is less than 1
Unit elastic: price elasticity is equal to 1
Determinants of price elasticity of demand
o substitution possibilities
o budget share
o time
Perfectly elastic demand: elasticity of demand is infinite, where demand curve is horizontal
Perfectly inelastic demand: elasticity of demand is 0, where demand curve is vertical
Cross-price elasticity of demand: percentage by which the quantity demanded of a good
changes in response to 1 percent change in price of a second good
Income-price elasticity of demand: percentage by which the quantity demanded of a good
changes in response to a 1 per cent change in income
Price elasticity of supply: percentage change in supply due to a 1 per cent change in price
Determinants of supply elasticity:
o Flexibility of inputs
o Mobility of inputs
o Ability to produce substitute inputs
o Time
Chapter 6 - Perfectly Competitive Supply: the Cost Side in the Market
Addition of multiple supply curves: add horizontally, from price to quantity
Profit maximisation firm: primary goal is to maximise the difference between revenue and
cost
Perfectly competitive markets (4 conditions):
o All firms sell the same standardised product
o Market has many buyers and sellers, which only exchanges in small quantity
o Sellers are able to leave and enter the market as they like
o Buyers and sellers are well informed
Short run: when at least one of the factors of production are fixed
Long run: when all firm's factors of production are variable
Fixed factors of production: input whose quantity does not change as output changes
Variable factors of production: input whose quantity changes as output changes
Law of diminishing returns: In the short run, successive increases in input of variable factor
eventually yield smaller output
Condition for short-run shutdown: firm should shut down if price is lower than the minimum
value AVC
If P x Q is less than VC for every level of Q
MC curve is upwards sloping due to diminishing return, and cuts the AVC and ATC at
minimum points
Chapter 7 - Efficiency and exchange
Pareto efficient: no opportunity for exchange that will make one person better off
any further trade will harm someone
Deadweight loss: reduction in total economic surplus that arises when market operate at
price and output other than the one at marginal benefit equals costs
Review the graphs
Chapter 9 - Quest for Profit and the Invisible Hand
Explicit Cost: the opportunity costs of resources supplied outside the firm, calculated as the
actual payment to its factors of production
Implicit cost: the opportunity costs of the next best alternative when it uses resources
supplied by owner
Economic profit: the difference between revenue and the sum of explicit and implicit costs
Economic loss: when economic profit is less than 0
Accounting profit: the difference between revenue and the explicit costs
Normal profit: (Implicit costs) the level of accounting profit when economic profit is zero and
is equal to the opportunity cost of the resources supplied to a business by its owners
When new firms enter markets with economic profits, output increases as shown by the
rightward shift in supply curve, reducing price and profit.
When existing firms leave markets with economic loss, causes leftwards shift in supply curve,
which increase price and profits
Rationing function of price: distribute scarce resources to those who place highest value
Allocative function of price: to direct resources away from overcrowded to underserved
markets
Invisible hand theory: actions of self-interested, independent buyers and sellers will result in
socially optimal allocation of resources
Economic Rent: part of payment for factor of production that exceeds the owner's
reservation price
Present value: amount of money we would need to invest today at a given interest rate in
order to generate a given amount of money at a specified date in the future
= M/(1+r)^t
Efficient markets hypothesis: theory that the current price of shares in company reflects all
relevant information about its current and future earnings prospects
'No Cash On The Table': if someone owns a valuable resource, the market price of the
resource reflect its economic value
Chapter 10 - Monopoly and other forms of Imperfect Competition
Imperfectly competitive market: when firms have some power over price
Pure monopoly: a market where a single firm produces all the output and there are no close
substitutes
Natural monopoly: a monopoly resulting from economies of scale
Oligopoly: a market where a few rival firms produces products of close substitutes
Monopolistic competition: a market where large number of firms produces close substitute
goods
Market power: ability for a firm to influence the demand & supply of goods, as well as price
Barriers to entry include:
o Exclusive control over inputs
o Government-created monopolies
o Economies of scale
Average total cost of production decreases as output rises [ATC=F/Q+M]
Total cost of production increase as output increases [TC=F+MQ]
Profit maximisation for price setters: marginal benefit is marginal revenue
Profit is maximised when marginal revenue equal marginal cost
Profit is only earned if the price is greater than the ATC
Price discrimination: charging different prices for the same product.
Perfectly discriminating firm: charging each buyer their exact reservation price for each unit
Group pricing: form of price discrimination where different discounts are offered in different
submarket
Perfect hurdle: an obstacles that completely segregates buyer whose reservation prices is
above it from those below it
Hurdle method of price discrimination: when a seller offers a discount for buyers who
overcome an obstacle

REVIEW THE EXAMPLES
Chapter 11 - Thinking Strategically
Basic elements of a game: (i) the players (ii) strategies available (iii) the playoffs
Dominant strategy: a strategy that gives the player the highest playoff, independent of the
other player's strategy
Dominated strategy: any other strategies other than the dominant strategy
Nash equilibrium: a point where no player has an incentive to deviate from their dominant
strategy
Prisoner's dilemma: a game where each player plays their dominant strategy and the
resulting playoff is smaller than if their dominated strategy was played. for e.g. game to
confess or remain silent
Repeated prisoner's dilemma: same game is played out with outcome observed from
previous games
Tit-for-tat: cooperate on the first move and then mimic opponent's move
Cartel: any group of firms that conspires and coordinate production and price prisoner's
dilemma: collusions break down as players have incentive to deviate from agreed strategy to
maximise its own profits
Credible threat: a threat to take an action that the threatener will carry out
Credible promise: a promise to take an action that the promised will carry out
Commitment problem: a situation in which people cannot achieve their goals because of
incredible threats and promises
Ultimatum game: where division of money is played. Player 1 proposes a solution and the
2nd player can either reject or accept
Chapter 12 - Externalities, Common Resources and Property Rights
External cost (negative externality): the cost of an activity that falls on those who didn't
pursue the activity
External benefit (positive externality): the benefit of an activity that falls on those who didn't
pursue the activity
When externalities are present, individuals will pursue in self interest, which will not result
in goods being produced at socially optimal level. Therefore outcome is inefficient.
Coase Theorem: when competitive markets, at no cost, can negotiate the purchase and sale
of right to perform activities that causes externality, they can always arrive at efficient
solutions to problems caused by externalities. For e.g. toxin in river example: one party can
offer payments in return for a favour, tax & subsidies
Market based instruments: policies that use a range of approaches to positively influence
the behaviour of people to achieve targeted outcome
Quantity market-based instruments: (cap and trade) carbon permits
Optimal level of pollution: when MB curve intersects MC curve. Indicates socially optimal
level of pollution
The problem of unused resources For e.g. number of cows sent onto a common grazing area.
Socially optimal number of cows in relation to marginal income
Common resources: resources that are difficult to exclude people and are rival
Tragedy of the commons: tendency of consumption of common resources until marginal
benefit is 0
Introduce private ownership to overcome this issue
Open access: when there is no restriction or regulation on a resource, exploitation is based
on first-come first serve
Common property: type of property rights regime where resources are controlled by
community of users, where rules are enforced locally
State property: type of property regime where resources are controlled by the government
and regulatory controls are centralised
Positional externality: when a change in one person's performance changes the expected
reward of another in situations in which depends on relative performance. For e.g.
completing master's degree to make employment easier
Positional arms race: a series of mutually offsetting investments in performance
enhancement that is stimulated by positional externality
Positional arms control agreements: an agreement in which contestants attempt to a
positional arm race
Chapter 13 - Public Goods and their Financing
Rivalry: the extent to which consumption of a good or service by one person diminishes the
availability to others
Excludability: the extent to which a good or service is excluded to non-payers
4 types of goods:
o Public goods: non-rival & non-excludable - e.g. national defence, parks
o Private goods: rival & excludable - e.g. cars, cheeseburger
o Collective goods: non-rival & excludable - e.g. pay-TV, toll road
o Common goods: rival & non-excludable - e.g. fish in the sea, the atmosphere
Free-rider problem: an incentive to not contribute to the provision of the good when
individuals can still consume the good without contributing to the cost
If marginal cost of producing a certain good is 0, then it would be inefficient to charge the
users of the good
Advantage of government-produced public goods is once a tax collection agency is
established, it can be expanded at relatively low costs to finance other goods
Advantage is government has the power to tax and can assign responsibility for recovering
the cost
Disadvantage of exclusive government-produced public goods is the tax system makes
taxpayers pay for good they don't want
Private provision of public goods:
o Funding by donation
o Development of new means to exclude non-payers
o Private contracting
The benefit of an addition unit of a private good is the highest sum that any individuals are
willing to pay
The benefit of an addition unit of a public good is the sum of the reservation price of all
people
Regressive tax: tax decreases in proportion as income increases
progressive tax: tax increases in proportion as income increases
proportional tax: pay the same percentage of income in tax
Taxes on inelastic activities may generate small deadweight loss, while taxes on negative
externalities may increase economic efficiency
Pork barrelling: enacting legislation whose total costs exceed total benefit, but is favoured
because their benefits from the expenditure by more than their share of the resulting extra
taxes
Logrolling: practise whereby legislators support one another's legislative proposals
Rent seeking: socially unproductive efforts of people or firms to win a prize
Crowding out: when government borrow funds from the private sector, causing increased
interest rates
Chapter 14: The Economics of Information
Middlemen: intermediary in a transaction of information
Expected value of gamble: the average outcome if the game is played infinitely.
Calculated as the sum of the product of outcome and their respective probability
Fair gamble: where expected value is zero
Better-than-fair gamble: where expected value is greater zero
Risk-neutral person: someone who accepts the gamble if it is fair or better
Risk-adverse person: someone who rejects all gamble
Asymmetrical information: where people on opposite sides in an exchange are not equally
informed
The Lemons Model: George Akerlof's explanation of how asymmetric information about the
characteristics of goods tend to reduce the average quality of used goods offered for sale
Principle-Agent problem: situation when the agent's actions are costly to monitor and
whose objective is not aligned with the principal's, takes action that favours the agent
Principal: someone who hires another party to provide goods and services on their behalf
Agent: someone who is hired by a principal
Costly-to-fake principle: idea that to communicate information credibly to a potential rival,
a signal must be costly or difficult to fake
Credibility problem can be overcome through warranties, mass advertisements -
Statistical discrimination: making judgements about the quality of people or products, based
on the groups they belong to
Adverse selection: when people on the informed side of a market (seeking insurance) self-
select in the actions they choose (to take insurance at a given price) in a way that those on
the other side are harmed
Moral hazard: tendency of people to change their behaviour once they become in a contract
Disappearing political discourse: theory that people who support a position remain silent as
speaking out would create a risk of being misclassified
First dollar insurance coverage: insurance that pays all expenses associated with claims
generated by insured activity