3: Equilibrium and Elasticity

Question 1

Equilibrium

Answer 1

a situation in which supply and demand are in balance

Question 2

Equilibrium Price

Answer 2

the price that sets quantity demanded = quantity supplied (price at which the supply & demand curves intersect)

Question 3

Equilibrium Quantity

Answer 3

is both the quantity demanded and supplied at the equilibrium price (quantity at which the supply and demand curves intersect)

Question 4

Characteristics of Surplus

Answer 4

• When the market price is higher than the equilibrium price, then there is a surplus (excess supply)
• Quantity supplied is larger than quantity demanded
• Suppliers lower price to increase sales, thereby moving towards equilibrium

Question 5

Characteristics of Shortage

Answer 5

• When the market price is lower than the equilibrium price, then there is a shortage (excess demand)
• Quantity supplied is smaller than quantity demanded
• Suppliers raise price due to too many buyers chasing too few goods, therefore moving towards equilibrium

Question 6

3 steps of Comparative Statics

Answer 6

1. Decide whether the exogenous event shifts the supply or demand curve (or both)
2. Decide in which direction the curve shifts
3. Use the supply and demand diagram to see how the shift changes the equilibrium (endogenous change)

Question 7

Elasticity

Answer 7

A measure of how much a variable responds to a change in one of its determinants.

Question 8

What is Price elasticity of demand

Answer 8

• The price elasticity of demand measures how much the quantity demanded of a good responds to a change in the own price of the good.

It is a measure of how sensitive consumers are to a change in the price of a good.

Question 9

Price elasticity of demand FORMULA

Answer 9

% change in quantity demanded / % change in price

Question 10

Elastic demand

Answer 10

• If price elasticity is greater than 1
• Buyers respond strongly to a change in price
• More precisely, a given percentage change in price leads to a proportionally larger percentage change in quantity demanded.

Question 11

Inelastic demand

Answer 11

• If price elasticity is less than 1
• Buyers do not respond strongly to a change in price
• More precisely, a given percentage change in price leads to a proportionally smaller percentage change in quantity demanded

Question 12

Unitary elasticity

Answer 12

• If equal to 1

- A given percentage change in price leads to a proportionally equal change in quantity demanded.

Question 13

4 determinants of price elasticity of demand

Answer 13

• Availability of close substitutes
• Necessities vs luxuries
• Scope of the market
• Time horizon

Question 14

Price elasticity + demand curves GENERAL RULE

Answer 14

The steeper (flatter) the demand curve, the lower (greater) the price elasticity of demand.

Question 15

Income elasticity of demand

Answer 15

measures how much the quantity demanded of a good responds to a change in consumers’ income

Question 16

Income elasticity of demand FORMULA

Answer 16

% change in quantity demanded / % change in income

Question 17

Cross price elasticity of demand

Answer 17

measures how much the quantity demanded of a good responds to a change in the price of a related good

Question 18

Cross price elasticity of demand FORMULA

Answer 18

% change in quantity demanded of good 1 / % change in price of good 2

Question 19

Price elasticity of supply

Answer 19

a measure of how much the quantity supplied of a good respond to a change in the price of that good.

Question 20

Price elasticity of supply FORMULA

Answer 20

% change in quantity supplied / % change in price