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CHAPTER 3: ELASTICITY

Elasticity
- measures the extent of effect or responsiveness of one variable when another variable changes
- measures the effect of the changes of the independent variable (goods-own-price, income, & price of other goods) in
the economy towards the dependent variable such as (goods-own quantity, quantity of other goods) in the case of
substitute and complementary goods
Price Elasticity
- Measures the responsiveness of the quantity being bought or sold to the change in the goods-own-price
- Measures the effect of the change in the price of a good to the quantity demanded/quantity supplied

PRICE ELASTICITY INCOME ELASTICITY CROSS-PRICE ELASTICITY PRICE ELASTICITY

OF DEMAND OF DEMAND OF DEMAND OF SUPPLY

measure of percent increase
in the quantity demanded of
g&s when there is a percent
increase in the price of such
measure of percent increase
in the quantity demanded of
g&s when there is a percent
increase in the buyer’s
income
measure of percent increase
in the quantity demanded of
goods and services when
there is a percent increase
in the price of another g&s
measure of percent increase
in the quantity supplied of
g&s when there is a percent
increase in the price of such

measures responsiveness of measures the measures the measures the

the Qd due to change in the responsiveness of the responsiveness of the responsiveness of the
goods-own-price quantity of goods bought quantity of one good when quantity supplied due to the
due to the change in income the price of another good change in goods-own-price
changes

■ If demand is elastic, an increase in P may not

benefit the producer

● Goods which are INELASTIC ( E < 1 )

○ Essential goods: (Infant’s milk, medicine, rice, water,
electricity, sugar, salt, spices, other utilities)
■ The more important or essential the goods are for
survival, the more inelastic the demand is.
■ If demand is inelastic, an increase in P will benefit
the producer because this will cause an increase
in this total revenue.

● Unitary elastic Goods ( E = 1 )

GOODS AND THEIR ELASTICITIES
● Goods which are ELASTIC ( E > 1 )
○ Luxurious goods: (Signature/branded bags, Perfumes,
Chocolates, High-end electronic gadgets, Imported
shoes, Travels)
■ lesser the necessity of a good = more elastic is
the demand
○ Semi-essential & semi-luxurious goods: (Dinner at
expensive restaurant, Purified water, Expensive clothes
■ Those goods which are essential but the moment
you inject a brand/want on it, it will become
semi-essential and semi-luxury
■ If the demand is unitary elastic, neither an
increase nor decrease in P will affect the sellers’
total revenue.

CHAPTER 4: CONSUMER BEHAVIOR

CONSUMER DECISION-MAKING

CATEGORIES OF CUSTOMER DECISION-MAKING

1. Cognitive - deliberate, rational. sequential
2. Habitual - behavioral, unconscious, automatic
3. Affective - emotional, instantaneous

A cognitive purchase decision is the outcome of a series of

stages that results in the selection of one product over
competing options.

CONCEPTUALIZING INVOLVEMENT

Different consumers may approach the same choice situation

from very different perspectives because of the consumer’s level
of involvement in the decision.

Involvement - a person’s perceived relevance of the object

based on their inherent needs, values, and interests.

TYPES OF INVOLVEMENT
1. Product - Product involvement is a consumer’s level of
interest in a particular product. As a rule, product decisions
are likely to be highly involved if the consumer believes
there is perceived risk.
2. Message - Message involvement refers to the influence
media vehicles have on consumers. Print is a
high-involvement medium while television tends to be
considered a low-involvement medium.
3. Situational - Situational involvement takes place with a
store, website, or a location where people consume a
product or service. One way to increase this kind of
involvement is to personalize the messages shoppers
receive at the time of purchase.
FIVE TYPES OF PERCEIVED RISK
1. Monetary risk - Occurs when making a poor choice will
have a monetary consequence
2. Functional risk - The risk that the product may not
function as the consumer needs.
3. Physical risk - The risk that the choice may physically
threaten the consumer.
4. Social risk - The risk that the choice will reflect poorly on
the consumer and damage his or her self-esteem or
confidence.
5. Psychological risk - The risk that one may lose
self-respect due to making a bad decision. Such as
consumer to feel extensive guilt.
COGNITIVE PURCHASE DECISION
- is the outcome of a series of stages that results in the
selection of one product over competing options.
STEPS IN THE DECISION-MAKING PROCESS
1. Problem recognition - occurs when we experience a
significant difference between the current state of affairs
and some state we desire.
2. Information search - the process by which we survey the
environment for data to make a reasonable decision
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3. Evaluation of alternatives - In the third stage, the
consumer evaluates the alternatives.
4. Product choice - Then a choice is made. The choice may
be from among product choices as well as to buy or not
STAGES IN CONSUMER DECISION MAKING
STAGE 1: PROBLEM RECOGNITION
➔ Occurs when consumer sees difference between current
state and ideal state
◆ Need recognition: actual state declines
◆ Opportunity recognition: ideal state moves upward
STAGE 2: INFORMATION SEARCH
➔ The process by which we survey the environment for
appropriate data to make a reasonable decision
◆ Prepurchase or ongoing search
◆ Internal or external search
◆ Online search and cybermediaries
STAGE 3: EVALUATION OF ALTERNATIVES
➔ Evoked Set - the set of product choices that you believe
are viable options for you to purchase based upon your
needs and desires relating to the product.
➔ Consideration Set - the subset of brands that consumers
evaluate when making a purchase decision. A consumer
has a limited information processing abilities and limits the
comparison to a subset of brands that is termed as
consideration set.
STAGE 4: PRODUCT CHOICE
➔ Now that the consumer has evaluated the different
solutions and products available for respond to his need, he
will be able to choose the product or brand that seems
most appropriate to his needs.
➔ Then proceed to the actual purchase itself
CONSUMER BEHAVIOR
In economics, a consumer usually responds to their utility and
that creates the consumer theory.
UTILITY - an individual's pleasure, happiness, or satisfaction is
CONSUMER THEORY - argues that individual consumption
decisions are always made because people desire to maximize
their satisfaction from consuming various goods and services
Maximizing our satisfaction is subject to different constraints.
ASSUMPTIONS OF FACTORS THAT BUYERS ARE AWARE OF
1. The spending on any good or service is exactly equal to
the individual's savings and income. This is only an
assumption because in reality, there are people who buy more
than their current savings or income.

2. People are aware of the range of products available in the
market. This is an assumption because there are instances
where people only buy a commodity out of pressure from another
individual without any idea of the product or service at all. In this
case, they cannot compare the added benefits of the product as
they did not look into alternative options.
3. People are aware of the prices of the products in the
market. The third assumption is important because there are
instances when people buy a commodity out of impulse or those
that they have no prior exposure to. In view of the urgency to buy
a commodity, people tend to disregard the price.
4. People are aware of the capacity of the product. This
simply means that we assume that whenever we buy a product,
we are completely aware of its functionality.
MEASURING UTILITY
CONSUMER THEORY - suggests that consumers rank all
consumption bundles based on the level of satisfaction they
feel after consuming these products or services
CONSUMPTION BUNDLES - certain combinations of two
commodities that will yield them a certain level of utility; these
bundles could form an indifference curve.
INDIFFERENCE CURVE - shows combinations of two
commodities which, when consumed, will yield the same level
of satisfaction; depicts values that are considered by the utility
function.
UTILITY FUNCTION - shows an individual's value of the utility
attained from consuming each conceivable bundle of goods.
These values could be either cardinal or ordinal.
➔ CARDINAL VALUES
- based on the number of "util" or the unit of satisfaction
- most widely used way in identifying utility
LAW OF DIMINISHING MARGINAL UTILITY (MU)
- increasing TU, but a decreasing MU; this law argues that as
you increase your intake of a certain commodity, you will
have a declining satisfaction on the next units of the same
commodity that you would consume
➔ ORDINAL VALUES
- based on rankings; e.g., likert scales
- it forms an indifference curve as well
MARGINAL RATE OF SUBSTITUTION (MRS)
- the maximum amount of a good that a consumer is willing
to give up to obtain one additional unit of another good
- slope of an indifference curve measures the consumer's
MRS between two goods
- diminishing trend along the indifference curve (as X
increases, Y decreases), making the curve convex
THREE PROPERTIES OF CONSUMER PREFERENCES
1. COMPLETENESS
In every pair of consumption bundles (X and Y), the
consumer can say one of the following:
a. X is preferred to Y.
b. Y is preferred to X
c. consumer is indifferent between X and Y. (If Missy is
indifferent, it means that the two goods are valued
equally)
2. TRANSITIVITY
- having commodities X, Y, and Z
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- It means that if X is preferred to Y, and Y is preferred to Z,
then X must be preferred to Z.
- not always correct, but they adequately describe most
people and most ordinary choices
3. NON-SATIATION
- more is better
- for economic goods, consumers always receive happiness
from more, or at least can freely dispose of any excess
from that
INDIFFERENCE MAP
- a graph containing a set of indifference curves showing two
commodities among which describe a person's preferences
- a consumer has an infinite number of indifference curves
that depict each level of their satisfaction
- higher indifference curve represents higher level of
satisfaction
- do not intersect; if indifference curves intersect, as one of
the assumptions of consumer theory is violated
- these indifference curves are often in line with the budget
of a certain individual.
- One's budget is a significant consideration in one's level of
happiness as it poses as a limitation. The budget of an
individual provides a ceiling to how many goods or services
he/she can enjoy. Hence, the budget line provides the
budget constraint of an individual.
BUDGET LINE
BUDGET CONSTRAINT
- limited budget on different types of commodities
- with this, we naturally try to limit our purchase of goods in
line with the current income that we have
BUDGET LINE
- a graph that shows the combinations of goods or services
of a person, where the total amount of money spent is
proportionate to his/her income
- it assumes that all people spend within the level of their
income
CONSUMER’S CHOICE
To maximize utility of an individual, it must satisfy two
conditions:
1. The decision must lie on the budget line.
2. The decision must lie on the indifference curve that is
depicting the most preferred combination of the consumer.
If income increases our demand for commodities will either
increase or decrease, depending on the type of commodity.
➔ Inferior good - an increase in income will decrease our
demand for this product.
➔ Normal good - an increase in income will increase our
demand for this product.
ENGEL CURVE - shows the relationship between the amounts
of product that people are willing to buy and their
corresponding income.
INCOME CONSUMPTION LINE was formed from the indifference
curves of the individual with different budget lines.
➔ If the two commodities are both normal goods, then we can
expect an increasing trend of purchase in these
commodities ( as income increases, the quantity (QA) that
is bought also increases).
➔ If the two commodities are both inferior goods, then we
can expect a decreasing trend of purchase in these
commodities (as income increases, the quantity (QA)
bought decreases).

SUMMARY
★ Individual consumption decisions are always made
because maximize their satisfaction from consuming
various goods and services.
★ There are four assumptions in consumer theory.
★ The law of diminishing marginal utility means that as you
increase your intake of a certain commodity, you will have a
declining satisfaction on the next units that you would
consume.
★ Budget line is a graph that shows combinations of goods or
services where the total amount of money spent is equal to
income.
★ To maximize the utility of an individual, it must satisfy two
conditions.
★ Consumer theory argues that consumers can rank all
consumption bundles that they acquired based on the level
of satisfaction they would receive from consuming these
products or services. These consumption bundles will yield
to an indifference curve. An indifference curve shows
combinations of values between two commodities, which
when consumed will yield the same level of satisfaction.
These values could be either cardinal or ordinal. Cardinal
values are based on the number of utils or the unit of
satisfaction. Ordinal values, meanwhile, are based on
rankings.
★ In analyzing the indifference curve, there are three
properties of consumer preferences that we have to take
note, namely: (1) completeness, (2) transitivity, and (3)
non-satiation.
★ Indifference curves cannot intersect.
★ An indifference map is a graph containing a set of
indifference curves showing two commodities among
which describe a person's preferences.
★ An Engel curve shows the relationship between the
amounts of product that people are willing to buy with their
income. It shows an increasing trend for normal goods and
decreasing trend for inferior goods.
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EXPLICIT COSTS
- The actual expenditures of the firm
- Accounting costs
IMPLICIT COSTS
- Value of the inputs owned and used by the firm
- Economic costs
- Cost that does not require the firm to give up money, but
rather opportunity
OPPORTUNITY COSTS - The opportunity cost associated with
choosing a particular decision is measured by the benefits
foregone in the next-best alternative
SUNK COST - The sunk cost is an expense that has already
been incurred and cannot be recovered
Marginal and Incremental ‘costs are used to help ‘management
evaluate ' different potential future courses of action.
INCREMENTAL COSTS
- are associated with a choice and therefore only ever
include forward-looking costs
- sunk costs not included
MARGINAL COSTS - refer to the cost to produce one more
unit of product or service
SHORT-RUN COST FUNCTIONS
COST FUNCTIONS -factors that determine costs
SHORT-RUN
- some of the firm's inputs are fixed c
- ost curves are operating curves
- TC = TFC + TVC

SHORT-RUN (PER-UNIT)
CHAPTER 5: REVENUE AND THE COST OF PRODUCTION ➔ ATC=TC/Q
➔ AVC =TVC/Q
➔ AFC = TFC/Q
COST THEORY AND ESTIMATION = ATC - AVC
➔ MC = ▲TC/▲Q
An important consideration in decision-making:
= ▲TVC/ ▲Q
● Nature of Costs
● Short-Run Cost Functions
AVC — average variable cost
● Long-Run Cost Curves
TVC — total variable cost
● Learning Curves Q — output level
● Cost-Volume-Profit Analysis w — wage rate
● The New Economies of Scale L — quantity of labor used
● Supply-Chain Management APL — average physical product of labor
● Empirical Estimation of Cost Functions MPL — marginal product of labor

NATURE OF COSTS LONG-RUN COST CURVES

RELEVANT COST LONG-RUN

A cost is relevant if it is affected by a management decision - All inputs are variable
● Opportunity cost - Cost curves are planning curves
● Marginal cost
● Incremental cost
● Sunk cost

- The U-shape of the LAC curve depends on increasing,

constant, and decreasing returns to scale
- The relationship of the LMC-LTC is the same as the
short-run MC-ATC.
RELATIONSHIP OF LONG-RUN AND SHORT-RUN AVERAGE
COST CURVES
- Long-Run average cost curve shows the minimum average
cost of producing any given level of output
- LAC curve is the tangent line to each of the short-run
average curves
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● Costs must be apportioned among products
MINIMUM EFFICIENT SCALE (MES)
● Costs must be matched to output over time
- The lowest output at which minimum average cost can be
● Costs must be corrected for inflation
achieved
- Important in determining how many firms a particular
market can support FUNCTIONAL FORM FOR SHORT-RUN COST FUNCTIONS
ECONOMIES OF SCOPE ● Theoritical Form
- The cost of producing multiple goods is less than the
aggregate cost of producing each item separately
- An important source of economies of scope is transferable
know-how

LEARNING CURVES
● Linear Approximation
- As firms gain experience in the production of a commodity
or service, their average cost of production usually declines
- from many experiences gained
- used to forecast needs for personnel, machinery, raw
materials and for scheduling production

COSIT-VOLUME-PROFIT ANALYSIS
(CVP Analysis / breakeven analysis)

- Examines the relationship among total revenue, total costs,

and total profits of the firm at various levels of output EFFICIENCY OF OPERATION IN ESTIMATING THE LAC
➔ TR = (P)(Q) CURVE
➔ TC = TFC + (AVC)(Q)
➔ TR = TC
OPERATING LEVERAGE (OL)
- refers to the ratio of the firms total fixed costs to total
variable costs
- Higher ratio = more leveraged
= profits are more sensitive to changes in
output or sales
- DOL degree of operating leverage
ARCHITECTURE OF IDEAL FIRM

● Core Competencies
● Outsourcing of Non-Core Tasks
● Learning Organization
NEW ECONOMIES OF SCALE ● Efficiency and Flexibility
● Location Near Markets
MINIMIZING COSTS INTERNATIONALLY ● Agility in Responding to Market Forces
● International trade in inputs
○ Foreign sourcing of inputs – requirement to remain REVENUE AND THE COST OF PRODUCTION
competitive
● New international economies of scale
REVENUE
○ Firms must constantly explore sources of cheaper
inputs and overseas production
○ Product development, purchasing, production, ● REVENUE - amount paid by the buyers to sellers (price) in
demand management, order fulfillment purchasing a commodity and the number of commodities
● Immigration of skilled labor being purchased (quantity).

Total Revenue = Price x Quantity

LOGISTIC OR SUPPLY-CHAIN MANAGEMENT
● Merging at the corporate level of the purchasing,
transportation, warehousing, distribution and customer
services functions rather than dealing with them separately
at division levels
○ Development of new and much faster algorithms that
greatly facilitate the solution of complex logistic
problems
○ Growing use of just-in-time inventory management
○ Increasing trend toward globalization of production
and distribution
EMPIRICAL ESTIMATION OF COST FUNCTIONS
- Planning for the long haul
EMPIRICAL ESTIMATION DATA COLLECTION ISSUES
➔ C = f (Q1, X1, X2, … , Xn)
● Opportunity costs must be extracted from accounting
cost data
● ACCOUNTING INCOME - income that is reflected in the
business records
Accounting Income = Total revenue - Total Cost
● ECONOMIC PROFIT - considers other types of cost
● EXPLICIT COST - actual costs being paid by the firm to its
suppliers, employees, and other expenses
● OPPORTUNITY COST - the value of something is what you
give up to get it; cost that an economist also considers to
arrive at his/her profit, called the economic profit; when
opportunity cost is included in the computation of profit, it
will be known as implicit cost
● IMPLICIT COST - the opportunity cost of pursuing one
option over the other.
Accounting Profit = Total Revenue - Explicit Cost

Economic Profit = Total Revenue - [Explicit Cost + Implicit
Cost]
PRICE & PRODUCTION
Prices are important in income management and costing
decisions.
FUNCTIONS OF PRICE
1. RATIONING - changes in price attributed to the distribution
of resources to consumers who need them the most; this is
like distributing resources (which are scarce) equitably
2. ALLOCATIVE - is the change in prices that direct resources
away from overcrowded markets and toward markets that
are undeserved; relate to concept of utilitarianism
CONCERNS OF PRODUCTION
PRODUCTION FUNCTION - shows the relationship between
quantity of inputs used to create a good and the quantity of
output produced.
If there is a production function, we also need to analyze
production at a margin. That could be done by looking at the
marginal product.
MARGINAL PRODUCT - change (increase or decrease) in
output from one additional unit of input (subtracting the
current value to its preceding value)
LAW OF DIMINISHING MARGINAL PRODUCT - marginal
product of an input decreases as the quantity of the input
increases
COSTS OF PRODUCTION
● FIXED COSTS (FC)
- costs that do not vary with the quantity produced.
- Examples of this type of cost are the monthly rent,
insurance payments, some government regulatory body
payments, and others.
● VARIABLE COSTS (VC)
- costs that vary with the quantity produced; input that the
firm shoulders for every unit of production that it has.
- Examples of these are raw materials, cost for laborers,
and other overhead costs.
● TOTAL COST (TC) - combination of fixed costs and variable
costs (TC = FC + VC)
OTHER MEASURES OF COST
● AVERAGE FIXED COST (AFC) - also called per-unit cost
and can be determined by dividing the firm's total cost by
the quantity of output it produces; Average Fixed Cost
decreases as quantity produced increases
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● AVERAGE VARIABLE COST (AVC) - Average Variable Cost
increases as Variable Cost increases
● AVERAGE TOTAL COST (ATC) - Average Total Cost
increases as Average Variable Cost increases; the lower the
Average Total Cost means more efficiency
ATC = AFC + AVC
● MARGINAL COST (MC) - increase/change in the total cost
(TC) from an additional unit of production; increase in the
variable cost (VC) in every additional unit of production
EFFICIENT SCALE
- is the quantity that minimize ATC
- when the MC crosses the ATC curve, company ' s
production are at the efficient scale
COSTS ARE LIKELY TO CHANGE
I. Economies of scale - state where longrun average total cost
falls as the quantity of output increases. This means that at
this point, if a firm wishes to increase its input, it can also
expect a higher-level output than the inputs made
II. Constant returns to scale - the state where long-run
average total cost stays the same as the quantity of output
increases. This means that increasing quantity will lead to the
same amount of cost. If we are at this point and we increase
our cost, we can just expect the same level of increase.
III. Diseconomies of scale - the state where long-run average
total cost rises as the quantity of output increases.
SUMMARY
★ Total revenue is driven by quantity and price. Changes on
any of the two will influence total revenue of firms.
★ Accounting profit is the result of subtracting explicit cost
from total revenue, while economic profit not only
subtracts explicit but also implicit costs from total revenue.
★ Prices have different functions: rationing and allocative.
The first is the distribution of resources equitably, while the
latter is the distribution of resources away from markets
where they may no longer be needed.
★ production function, Marginal product
★ Law of diminishing marginal product
★ The costs of a production are listed as follows: (1) fixed
costs, (2) variable costs, and (3) total cost. The average
costs = of these values are also called per-unit cost, and
can be determined by dividing the firm's total cost by the
quantity of output it produces. The lowest point of the ATC
is called the efficient scale output. Meanwhile, when MC
crosses the ATC curve, it is at the efficient scale.
★ In the long run, all of the costs are already variable.
★ LRATC will show us three possible scenarios, namely:
economies of scale, constant returns to scale, and
diseconomies of scale.