Elasticity and Total Revenue) Explain the relationship between the price elastic

Question

Elasticity and Total Revenue) Explain the relationship between the price elasticity of demand and total revenue.


(Determinants of Price Elasticity) Would the price elasticity of demand for electricity be more elastic over a shorter or a longer period of time?


(Explicit and Implicit Costs) Determine whether each of the following is an explicit cost or an implicit cost:
a. Payments for labor purchased in the labor market
b. A firm’s use of a warehouse that it owns and could rent to another firm


(Long-Run Average Cost Curve) Explain the shape of the long-run average cost curve. What does “minimum efficient scale” mean?

When a government wants to increase tax revenue, they will often increase the sales tax on gasoline. Using price elasticity of demand, explain why the tax would be placed on gasoline rather than, say, yachts. What might be the long run effect of raising the price of gas?

The shape of the long-run cost curve is determined by economies and diseconomies of scale. Contrast this curve with the short-run cost curve as it relates to increasing and diminishing marginal returns to labor.

Explanation / Answer

"Elasticity and Total Revenue) Explain the relationship between the price elasticity of demand and total revenue." A firm maximizes revenue when price elasticity of demand is equal to 1 (unit elasticity). If demand is inelastic, the firm can earn more revenue by increasing the price. If the demand is elastic, the firm can earn more revenue by decreasing the price. This is because the formula for price elasticity is: E = %change in Quantity / %change in Price. And the formula for revenue is: R = P*Q If E is greater than 1, this implies that the quantity increases more than price decreases. So, revenue will increase if price decreases. If E is less than 1, this implies that the quantity decreases more than price increases. So, revenue will increase if price increases. If E is equal to 1, this implies that quantity increases (decreases) the same as price decreases (increases). So, revenue will not change as a result of a change in price. This is characteristic of a maximum. "(Determinants of Price Elasticity) Would the price elasticity of demand for electricity be more elastic over a shorter or a longer period of time?" The price elasticity of demand for electricity would be more elastic in the long term as people have more options in the long term. They can buy electricity from a different company. They can weatherproof their house better. They can move to a smaller house. These are things they may not be able to do in the short term. "Determine whether each of the following is an explicit cost or an implicit cost: a. Payments for labor purchased in the labor market b. A firm’s use of a warehouse that it owns and could rent to another firm" a. This is an explicit cost because you actually have to pay it. b. This is an implicit cost. That is, it is an opportunity cost. The firm doesn't actually have to pay this cost out in the form of currency. "(Long-Run Average Cost Curve) Explain the shape of the long-run average cost curve. What does “minimum efficient scale” mean?" The long run average total cost curve is shaped like a bowl. In the area left of the minimum, the firm experiences increasing returns to scale. In the area to the right of the minimum, the firm experiences decreasing returns to scale. At the minimum, the firm experiences minimum efficient scale. This means that the firm cannot lower its average total cost more by either increasing or decreasing production. "When a government wants to increase tax revenue, they will often increase the sales tax on gasoline. Using price elasticity of demand, explain why the tax would be placed on gasoline rather than, say, yachts. What might be the long run effect of raising the price of gas?" The price elasticity of demand for gasoline is relatively inelastic. That means that increasing the price will have only small decreases in quantity. This also means that the tax revenue will be greater for a good with an inelastic demand rather than an elastic demand. Yachts have a price elastic demand. The long run effect of raising the price of gasoline is that people buy more fuel efficient cars, which allow them to drive more while consuming less gasoline. As a result, gasoline tax revenue will be decreasing in the long run. "The shape of the long-run cost curve is determined by economies and diseconomies of scale. Contrast this curve with the short-run cost curve as it relates to increasing and diminishing marginal returns to labor." When the number of workers is small, you may get increasing marginal returns to labor through specialization and synergy. Then, as the number of workers grows larger, management and organization become difficult. So, you start to get diminishing marginal returns to labor. The productivity of labor relates to costs because the more productive workers are, the fewer of them you need to produce any given quantity of a good and the less you have to pay in wages. As a result, the short-run cost curve is shaped like a bowl. In the area left of the minimum, the firm experiences increasing marginal returns to labor. In the area left of the minimum, the firm experiences decreasing marginal returns to labor. At the minimum, the firm experiences a constant return to labor.

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