Economics Dr.

Sauer

Chapter 2 Lecture Handout 2.3.1 Demand and Supply Demand and Supply are often modeled by simple linear equations. P = a bQ P = c + dQ A. Demand Example: P = 100 0.5Q vertical intercept: horizontal intercept: slope and interpretation of slope:

B. Supply Example: P = 10 + 0.5Q vertical intercept: horizontal intercept: slope and interpretation of slope:

(do on your own PE 2.3 page 69) _____________________________________________________________________ Cost and Revenue 2.3.2 Cost The cost of production typically has two components: Fixed Costs and Variable Costs. Cost is always a function of the quantity produced. TC = FC + VC TC=f(Q) Example: TC = 20 + 4Q vertical intercept: slope:

2.3.3 Revenue A firm receives revenue when it sells its output. Total Revenue is equal to the quantity sold times the price charged. TR = P x Q If each unit sells for the same price, then Total Revenue is a straight line. Example: Suppose the market price is $3.50, then TR = 3.5Q. The way to interpret the slope is ?

The vertical and horizontal intercepts are both zero. Why?

(PE 2.4 page 75) #7 A trader who sells watches at the Saturday flea market has fixed costs of $90 and buys watches wholesale at $3 each. He sells the watches for $6 each. Write the equations for each of the following: Fixed Cost Variable Cost Total Cost Total Revenue Now graph the TC equation for Q=0 to Q = 40.

Now graph the TR equation for Q = 0 to Q = 40.

________________________________________________________________________ 2.5 Translations of linear functions Translating a line means moving it, intact, to another position. Its slope and length do not change. Its vertical intercept is changed. Its equation will change.
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Examples: A. Tax on a good or service A tax is levied on the supplier. The government collects a fixed amount of money for each unit of the good sold, irrespective of the selling price. Original supply: P = 10 + 0.5Q Supply with a tax of $2 per unit:

Supply with a tax of $0.50 per unit:

B. Subsidy for production costs Suppose that in order to encourage a particular type of production, the government grants a subsidy to the firm. Original cost function: TC = 20 + 4Q Cost function with a subsidy of $10:

Cost function with a subsidy of $4: (PE 2.6 handout) #4 The supply function for toolboxes is given by P=100 +0.4Q. Deduce the equation of the new supply function when, a. a subsidy of $5 per unit is introduced.

b. a tax of $10 per unit is imposed.

c. Calculate the price charged when the quantity demanded is 50 according to -the original supply function

-the subsidized supply

-the taxed supply

2.6 Elasticity Elasticity is the ratio of the percentage change in the quantity to a percentage change in an economic variable like price or income. A. Price Elasticity of Demand measures the responsiveness of quantity demanded to changes in the goods own price.

or in simplified form:

Remember that the slope of the linear demand curve is equal to So, =

or b.

Given any linear demand function, the formula for point elasticity of demand is

1. Point Elasticity: If you know a particular price and quantity, then you can calculate the elasticity of demand at that point. Example: P = 2400 0.5Q Determine the point elasticity of demand when P = 1800.

Elasticity varies along a linear demand function.

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Note: Point elasticity of demand depends only on price and the vertical intercept.

2. Arc price elasticity of demand measures the elasticity of demand over an interval. - average of the price and quantities at the beginning and end of the interval - aka the midpoint formula ( ( For a linear demand function: ) )

Example: P = 2400 0.5Q Determine the arc elasticity of demand over the range of P = 1800 to P = 1200.

B. Price Elasticity of Supply measures the responsiveness of quantity supplied to changes in the goods own price. Point price elasticity of supply:

Arc price elasticity of supply:

(PE 2.7 page 91)

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2.7 Budget and Cost Constraints A. A budget constraint (or budget line), relates the amount of goods that a consumer can afford to purchase to his/her income and prices. Consider a consumer who spends all of his/her income, M, on two goods, X and Y, priced at PX and PY per unit respectively. The consumer can choose to spend his/her income on: Only X: Only Y: A combination of the two goods: Rearranging the constraint we get:

Example: A consumer has a given income, M = $180 which is spent on two goods X and Y. The prices of these goods are PX = $2 and PY = $6 respectively. (a) Deduce the equation of the budget constraint. (b) Graph the consumers budget constraint.

When the price of a good rises: falls:

When the consumers income rises: falls:

Example: Suppose the consumer now has $200.

Example: Suppose the consumer has $180 but the price of good x increases to $3.

B. A cost constraint (also known as an isocost line), relates the amount of inputs that a firm can afford to purchase given its total allowable expenditure (budget) and the cost per unit of the inputs. Assume that the inputs are labour, L, and capital, K, the cost per unit of labour is the wage rate (w), the cost per unit of capital is rent (r), while the firms total allowable expenditure is C. A firm can allocate its expenditure on: Only L: Only K: A combination of L and K:

The general equation for the isocost line is:

(PE 2.8 handout) #6 A producer uses labor and capital to produce computers. The firms total cost is $21,000. The price of labor is $5.60 per unit and the price of capital is $3.50 per unit. Write the equation for the isocost line. Illustrate on a graph.

Complete the Chapter 2 Test Exercises, page 99.

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