Chapter 2: Demand and Supply Analysis Flashcards
chapter 2 study guide
The three dimensions of a market
Commodity: the product bought and sold
Geography: the location in which purchases are being made
Time: the period of time during which transactions are occurring
Market demand curve
A curve that shows us the quantity of goods that consumers are willing to buy at different prices
Derived demand
Demand for a good that is derived from the production and sale of other goods
Direct demand
Demand for a good that comes from the desire of buyers to directly consume the good itself
Law of demand
The inverse relationship between price of a good and quantity demanded when other factors that influence demand or held fixed
Market supply curve
A curve that shows us the total quantity of goods that their suppliers are willing to sell at different prices.
Law of supply
The positive relationship between price and quantity supplied, when other factors that influence supply are held fixed
Factors of production
resources such as labor and raw materials that are used to produce a good
(market) equilibrium
a point at which there is no tendency for the market price to change as long as exogenous variables remain unchanged.
excess supply
a situation in which the quantity supplied at a given price exceeds the quantity demanded
excess demand
a situation in which the quantity demanded at a given price exceeds the quantity supplied.
PRICE ELASTICITY OF DEMAND [PED]
a measure of the rate of percentage change of quantity demanded with respect to price, holding all other determinants of demand constant.
WHAT DOES IT MEASURE: the sensitivity of the quantity demanded to price.
FORMULA:
εₚ = (%∆ in Quantity) / (%∆ in Price)
[note: it is ε subscript Q,P]
Perfectly Inelastic Demand [ε=0]
[When price elasticity of demand = 0]
(demand curve is a straight vertical line): |
When quantity demanded is completely insensitive to price.
Inelastic Demand [-1<ε<0]
[When price elasticity of demand is between 0 and -1]
(slope of the demand curve is greatly decreasing): \
When quantity demanded is RELATIVELY insensitive to price.
[ie gasoline, utilities, etc]
(Unit Elastic) Unitary Elastic Demand [ε=-1]
[When price elasticity of demand is -1]
(slope of the demand curve is basically 1)
Percentage increase in quantity demanded is equal to percentage decrease in price.
Elastic Demand [-∞<ε<-1]
[when price elasticity of demand is between -1 and -∞]
(slope of the demand curve is approaching a flat line)
Quantity demanded is relatively sensitive to price
[ie if water bottles are $3 each, I will only buy one, but if it goes down to $1/bottle, I’ll buy 2 or 3]
Perfectly Elastic Demand [ε= -∞]
[when price elasticity of demand is -∞]
(slope of the demand curve is a horizontal line): ––
Any increase in price results in quantity demanded decreasing to zero, and any decrease in price results in quantity demanded increasing to infinity.
Linear Demand Curve
A demand curve in the form:
Q = a - bP
Q = quantity demanded
a = positive constant; embodies the effects of all the factors (e.g. income, prices of other goods) other than price that affect demand for the good
b = positive coefficient that reflects how the price of the good affects the quantity demanded.
P = price of good demanded
Inverse demand curve
an equation for the demand curve that expresses price as a function of quantity.
P = (a/b) - (1/b)Q
(a/b) = choke price, or the price when the quantity demanded falls to 0.
Choke Price
(a/b) in an inverse demand curve
The price at which the quantity demanded falls to 0.
Formula for Price Elasticity of Demand f/ linear demand curve
εₚ = (∆Q/∆P) ✖️ (P/Q)
εₚ = -b✖️(P/Q)
*Midpoint (M): εₚ = -1; Q =a/2 & P=a/2b
*Elastic Region: -∞ < εₚ < -1
*Inelastic Region: -1 < εₚ < 0
The formula tells us that for a linear demand curve, the price elasticity of demand varies as we move along the curve.
Elastic Region of the Demand Curve
Area between the choke price a/b (where Q=0) and a price of a/2b at the midpoint M of the demand curve, the price elasticity of demand is between -∞ and -1.
*Price Elasticity of Demand: -∞ < εₚ < -1
*Quantity: 0 < Q < (a/2)
*Price: (a/2b) < P < (a/b)
Inelastic Region of the Demand Curve
Area for prices between a/2b and 0, the price elasticity of demand is between -1 and 0.
*Price Elasticity of Demand: -1 < εₚ < 0
*Quantity: (a/2) < Q < a
*Price: 0 < P < (a/2b)
Constant Elasticity Demand Curve
General formula:
Q = aP^-b
A demand curve of the form Q = aP^-b, where a and b are positive constants. The term -b is the price of elasticity of demand (εₚ) along this curve
Total Revenue
(Selling price) ✖️ (quantity of product sold)
What happens to Total Revenue if: (elastic demand)
If the demand is elastic, the quantity reduction will outweigh the benefit of a higher price => TR will FALL.
[elastic means the quantity demanded is relatively sensitive to price]
What happens to Total Revenue if: (Inelastic demand)
If the demand is INELASTIC, the quantity reduction will not be too severe => TR will go UP!
[inelastic means the quantity demanded is relatively INSENSITIVE to price]
3 Factors that determine a product’s Price Elasticity of Demand
(from pg 49 in textbook): Here are some factors that determine a product’s price elasticity of demand–the extent to which demand is relatively sensitive or insensitive to price:
1) good substitutes exist
2) when consumer’s expenditure is large
3) when good is a necessity
In more detail:
*Demand tends to be more price elastic when good substitutes exist for a product.
––(or demand tends to be less price elastic when the product has few or not very satisfactory substitutes) [ie travel options for leisure travelers b/c fly, drive, bus, etc]
*Demand tends to be more price elastic when a consumer’s expenditure on the product is large.
––(either in absolute terms or as a fraction of total expenditures) [ie for refrigerators and automobiles where the gain from carefully evaluating the purchase and paying close attention to the price is greater than it is when the item does not entail a large outlay of money]
*Demand tends to be less price elastic when consumers see the product as being a necessity. [ie rice, eggs, milk–you’re gonna buy them anyways because you eat them everyday]
INCOME ELASTICITY OF DEMAND
The ratio of the percentage change of quantity demanded to the percentage change of income, holding price and all other determinants of demand constant.
ε (subscript Q, I) but we’ll call εₗ, I because income as opposed to p for price
εₗ = ((∆Q/Q)✖️100%) / (∆I/I)✖️100%)
Or,
εₗ = (∆Q/∆I) ✖️ (I/Q)
Cross Price Elasticity of Demand [CPED]
The ratio of the percentage change of the quantity of one good demanded with respect to the percentage change in the price of another good.
ε (subscript Qᵢ, Pⱼ) = ((∆Qᵢ/Qᵢ) ✖️ 100%) / ((∆Pⱼ/Pⱼ) ✖️ 100%)
Or
εᵢⱼ = (∆Qᵢ / ∆Pⱼ) ✖️ (Pⱼ/ Qᵢ)
If CPED or εᵢⱼ > 0, a higher price for good j increases the quantity of good i demanded.
Demand Substitutes
Two goods are related in such a way that if the price of one increases, demand for the other increases.
CPED > 0 ==> substitutes
if the εᵢⱼ or CPED (cross price elasticity of demand) > 0, a higher price for good j increases the quantity of good i demanded —> i and j are substitutes
Demand COMPLIMENTS
Two goods related in such a way that if the price of one increases, demand for the other decreases.
CPED < 0 ==> compliments
if the εᵢⱼ or CPED (cross price elasticity of demand) < 0, a higher price for good j decreases the quantity of good i demanded –> i and j are compliments
Price Elasticity of SUPPLY [PES]
The percentage change in quantity supplied for each percent change in price, holding all other determinants of supply constant.
It measures the sensitivity of the quantity supplied to price.
ε (Subscript Q^s, P) = ((∆Q^s/Q^s) ✖️ 100%) / ((∆P/P) ✖️ 100%)
εₛ = (∆Q^s/∆P) ✖️ (P/Q^s)
What does the Price Elasticity of Supply measure?
It measures the sensitivity of quantity supplied to price
Long-Run Demand Curve
Demand curve that pertains to the period of time in which consumers can fully adjust their purchase decisions to changes in price
Short Run Demand Curve
The demand curve that pertains to the period of time in which consumers cannot fully adjust their purchase decisions to changes in price
Long-run supply curve
the supply curve that pertains to the period of time in which producers can fully adjust their supply decisions to changes in price
Durable Goods
Goods, such as automobiles or airplanes, that provide valuable services over many years
Short-Run supply curve
the supply curve pertains to the period of time in which sellers cannot fully adjust their supply decisions in response to changes in price
Nondurable goods
goods that are immediately consumed in one use or have a lifespan of less than three years
