Elasticities
We are now going to shift our attention to taking a closer look at our economy. With macroeconomics, we reviewed
concepts that affected our economy as a whole. Microeconomics enable us to examine revenue, costs, profits, and eco-
nomic costs generated by individual business.
It is wise on the part of individuals and firms to evaluate both the costs and benefits of a decision. Individuals base their
decisions on the availability of incentives that appeal to their self-interests. Firms also base their decisions on incen-
tives, and one main incentive firms consider before making a decision is profit. The expected profit helps firms evaluate
the costs and benefits of a decision. As you learned in Chapter 1, costs and benefits do not necessarily have to carry a
price tag. There are both monetary and nonmonetary values to both costs and benefits. Opportunity cost and rational be-
havior play a large role in decision making and sorting through the monetary and nonmonetary costs. Rational behavior
involves recognizing that people make decisions based on self-interest and what will make them the happiest. People
compare the additional or marginal benefits or costs that each choice will bring them. It is the next glass of water, the
next minute, the next day, or the next dollar that influences people’s decisions.
People compare the marginal benefits and marginal costs of every decision. If marginal benefits outweigh the marginal
cost of some choice, then people make that choice. If marginal benefits are less important than the marginal costs of a
particular decision, then people do not make that choice. Individuals make the decision to trade and exchange. When
people choose to trade or exchange, they do this only if they feel that they are going to benefit from it.
Microeconomicsis the branch of economics that examines choices and interaction of individuals in which the unit of
analysis is oneperson, oneproduct, onefirm, or oneindustry. This branch is concerned primarily with individual deci-
sion making. An example of a microeconomic choice is how individual beef farmers respond to higher beef prices in
the market. Each farmer must decide whether to supply more or less or the same amount of beef to the market.
Individual consumers must decide whether to buy more, less, or the same amount of beef.
In Part II, we examine choices made by individuals and the incentives that help them make choices. Individuals are
motivated by incentives all the time. Incentives drive people into making decisions, whether it’s going to the grocery store
or deciding how much to charge for a shirt. Incentives are based on an individual’s self-interest. One common incentive
producers have is profit. Profit drives producers to compete, be efficient, and provide some good in a market economy.
If Jerry opens a lemonade stand, he was probably motivated by the possibility of making a profit on his lemonade.
Profit, however, is not to be confused with revenue. Revenueconsists of all the monies generated as a result of a sale
of a product. You determine profit by taking that revenue and subtracting the costs from it.
At this point in our discussion, you need to be familiar with two types of costs: implicit and explicit costs. Explicit costs
are what you see on the surface when operating a business. Monetary values of labor, power, raw materials, and machines
are all explicit costs. Implicit costspertain to opportunity costs, trade-offs, and time. These are all things producers con-
sider when making decisions for their business. Economists argue that all costs are not considered until the implicit costs
are weighed. You may ask, “How do I determine the value of the implicit costs?” You do this by determining the value of
the assets that are given up. If Jerry, our lemonade entrepreneur, chooses to sell lemonade on a cold winter day, what could
he be giving up? It’s likely that selling hot chocolate would have been a wiser decision on a cold day. Jerry’s opportunity
cost becomes the additional sales he lost by not selling hot chocolate. Jerry’s explicit costs may include lemons, water,
cups, and sugar. Depending on whether Jerry has anyone working for him, labor could be another cost. To determine a
profit for accounting purposes, Jerry must take the price for a glass of lemonade, multiply it by the number of glasses sold,
and then subtract from that number all the explicit costs. Here’s the formula for figuring profit:
Profit = Total Revenue – CostElasticity of Demand
Suppose you are in charge of setting the price for a single slice of pizza. Your business has not been doing very well as
of late, and competing firms have been snatching up market power. You are left with very few options at this point;