| Line 25: |
Line 25: |
| | Price elasticity of demand is important because it tells us whether the owner's | | Price elasticity of demand is important because it tells us whether the owner's |
| | overall revenue goes up or down due to a price change. Revenue is price times quantity, and when price goes up then quantity goes down, and we need to know the price elasticity to know what happens to the overall price times quantity. | | overall revenue goes up or down due to a price change. Revenue is price times quantity, and when price goes up then quantity goes down, and we need to know the price elasticity to know what happens to the overall price times quantity. |
| | + | |
| | + | Mathematically, price elasticity is as follows: |
| | + | |
| | + | :<math>Ped = \frac{% \Delta (Quantity-demanded-of-good)}{% \Delta (Price-change-in-good)}</math> |
| | + | |
| | | | |
| | === Income Elasticity === | | === Income Elasticity === |
| Line 66: |
Line 71: |
| | |- | | |- |
| | |} | | |} |
| | + | |
| | + | Mathematically, income elasticity is as follows: |
| | + | |
| | + | :<math>Yed = \frac{% \Delta (Quantity-demanded-of-good)}{% \Delta (Change-in-income-of-buyers-of-good)}</math> |
| | | | |
| | === Cross Elasticity === | | === Cross Elasticity === |
| Line 85: |
Line 94: |
| | === Supply Elasticity === | | === Supply Elasticity === |
| | | | |
| | + | One more and we're done. The price elasticity of '''''supply'''' is the percent change in quantity supplied divided by the percent change in price for the good. Mathematically, that is: |
| | | | |
| − | == Introduction to Short and Long Run ==
| + | Mathematically, cross elasticity is as follows: |
| − | | |
| − | Last lecture we focused solely on “demand”. This time we turn to “supply”. We look at how companies decide how much product to make and put out into the market. How many goods should a company produce, or how many services should it provide?
| |
| − | | |
| − | The vice of limiting supply (from question 7 on last homework; consumer surplus)
| |
| − | | |
| − | Before we start, however, we define two terms essential to economics: the “short run” and the “long run.” As its name implies, the “short run” is a relatively short period of time in which a company can only make temporary changes to its operation. In a sporting contest, the “short run” would during a game, when the coach decides to substitute his players or alter the game plan to try to win that particular contest. During the “short run” only quick and temporary reactions by a company or firm to a fluctuation in demand are possible. For example, changes like using more overtime labor would be a short run adjustment. Or telling workers to take an extended vacation due to lack of demand for the goods would be another short run change. This class we will be focusing on the “short run.”
| |
| − | | |
| − | In the “short run” it is impossible to change the fixed costs, or “sunk costs.” The cost of factory, and the equipment inside, cannot be altered. These fixed costs can be easily measured by seeing what the total costs are when output is zero. That is because when output is zero, there are no marginal costs, and all the costs are the fixed ones.
| |
| − | | |
| − | The “long run” consists of a time period long enough to make basic and permanent changes, like building new factories, buying new equipment, and hiring and training new employees. In a sporting contest, it would include scouting and drafting new players, or building a new weight room. Everything can be adjusted in the “long run”: workforce, facilities, materials, equipment, investment, etc. We’ll discuss the “long run” next class.
| |
| − | | |
| − | For now, let’s focus on the “short run.” The key concepts are “marginal cost” and “marginal revenue.” How much does it cost to make one more widget, and much revenue does that extra widget generate for the company? That additional cost per unit is called “marginal cost.” The additional revenue per unit is called “marginal revenue.” As long as marginal revenue is slightly higher than marginal cost, then it makes sense to produce that extra widget. Typically, companies continue making more and more goods until marginal revenue falls below marginal cost, at which time they stop production because they begin to lose money on each additional good they produce.
| |
| − |
| |
| − | ==The Short Run==
| |
| − | | |
| − | Imagine yourself as the President of a company making widgets, our imaginary good. If it costs you $200 to make 10 widgets and $205 to make 11 widgets, then what is your marginal cost (MC) of the 11th unit? It is only $5. What is its average cost? Nearly $19 ($205 total cost divided by 11 total units). Average cost is often greater than the marginal cost. This makes sense, because once you pay for your factory and workers, you do not have much additional cost to produce an extra unit. This is called economies of scale: the bigger your operation, the cheaper you can make one more unit.
| |
| − | | |
| − | Think of a baking some bread. It requires some time and effort to bake one loaf of bread. But there is not as much extra effort to stick another loaf in the oven.
| |
| − | | |
| − | Or imagine going to a baseball game. The cost for one person to go is the ticket price plus the cost of gas and parking and wear and tear on the car. The cost for a second person to go with the first person is just the price of the ticket. There is no extra gas or parking or wear and tear on the car for a second person to ride along. So the marginal cost for the second person is much less than for the first person.
| |
| | | | |
| − | But let’s return to your role as President of the widget company. You are deciding how many employees to hire. You have an assembly line that needs workers. Each additional employee that you hire to work on that assembly line increases the “marginal product of labor,” which is the increase in output for each additional unit of labor. It is often called “MP”.
| + | :<math>Pes = \frac{% \Delta (Quantity-supplied-of-good)}{% \Delta (Price-change-in-good)}</math> |
| | | | |
| − | Let’s explain MP a different way to make sure you understand it. The more workers you hire, the more goods your company can produce. Suppose you can make 1000 widgets a week with 10 employees. Then you hire one more employee, and your output increases to 1015 widgets. What is the “marginal product of labor,” or MP, for your 11th employee? It is 1015-1000=15. Note that is less than the average product of labor, which 1015/11 = 92.3 for 11 employees. You are suffering from “diminishing marginal returns.” You received much more benefit from the 1-10 employees you hired earlier (their average product of labor is 100) than this 11th employee (with its MP of only 15).
| + | If the supply elasticity (Pes) is inelastic (less than 1), then it is difficult for suppliers to react quickly to a change in price. If Pes is elastic (more than 1), then suppliers can react quickly to a change in price, as in supplying more goods when the price increases. |
| − | | |
| − | Again, this makes sense. As you hire more and more employees, your benefit from will eventually decline. Once the assembly line has enough workers to satisfy demand, for example, you would be wasting money by hiring additional workers. They would end up spending the day talking to each other rather than doing productive work. If you were to keep hiring employees, then eventually the MP for your next employee would fall to zero. He would have nothing productive to do.
| |
| − | | |
| − | On the other side, however, the MP for your first employee would be greater than zero. Additional employees might have even higher MPs because you are filling your assembly line. If your assembly line needs 10 employees to run it, then the MP for your 10th employee will the highest of all. After that, the MP begins falling.
| |
| − | | |
| − | In general, MP rises as your initial employees are hired, eventually reaches a maximum at some point and then falls back towards zero for each additional employee. It is an upside-down oval, beginning at MP=0 for 0 employees and returning to MP=0 for a large number “n” of employees. The value of “n” depends on the business.
| |
| − | | |
| − | The optimal number of employees for an NBA basketball team, when MP is its maximum, is only about a dozen players. The optimal number of employees for Wal-Mart, when MP is its maximum, is over 1 million employees. So it all depends on what the company is producing.
| |
| − | | |
| − | Can we can find the marginal cost (MC) of making that extra widget based on (i) the wages we have to pay the extra employee and (ii) his marginal productivity (MP)? If it costs us $100 to hire one more employee, and he enables us to make 10 more widgets, then our marginal cost (MC) is simply $100/10 = $10 per unit. In other words, MC = wage/MP.
| |
| − | | |
| − | Let’s make sure we understand this by looking at another example. Suppose that hiring one more sales agent at $80 per day in our clothing store enables us to sell 8 more dresses. What is our marginal cost for dresses at that point? It is simply the additional cost of $80 (the wage) divided by that employee’s marginal productivity of 8 new sales, yielding a marginal cost of $10 per dress.
| |
| | | | |
| | ==Efficiency== | | ==Efficiency== |
| Line 175: |
Line 153: |
| | | | |
| | === The Man Behind the Coase Theorem === | | === The Man Behind the Coase Theorem === |
| − |
| |
| | | | |
| | Who is this man behind this revelation? It took an unconventional education to bring forth this unconventional work. Professor Ronald Coase, born in 1910 in England, suffered from a physical handicap as a youngster and thus could not attend regular school. He had to wear leg braces and was eventually enrolled in a school for “physical defectives.” But that school was managed by the same organization that ran the school for “mental defectives,” and Coase later explained that there was “some overlapping in the curriculum.”<ref>http://www.reason.com/news/printer/30115.html</ref> As a result, Coase spent his days in basket-weaving classes, and was deprived of any formal academic instruction until age 10. | | Who is this man behind this revelation? It took an unconventional education to bring forth this unconventional work. Professor Ronald Coase, born in 1910 in England, suffered from a physical handicap as a youngster and thus could not attend regular school. He had to wear leg braces and was eventually enrolled in a school for “physical defectives.” But that school was managed by the same organization that ran the school for “mental defectives,” and Coase later explained that there was “some overlapping in the curriculum.”<ref>http://www.reason.com/news/printer/30115.html</ref> As a result, Coase spent his days in basket-weaving classes, and was deprived of any formal academic instruction until age 10. |