Chapter 4

Question 1

What is elasticity?

Answer 1

How responsive is the quantity changes in price

Very response: elastic (flat)

Not very responsive: inelastic (steep)

location + inclination

“temp” + “pressure”

thermometer + barometer

(P/Q) x (1/slope)

Question 2

What are the four types of elasticity?

Answer 2

1. Price elasticity of demand
   
   1. Measurement
   2. Determinants
   3. Elasticity and Total Revenue
2. Price elasticity of supply
   
   1. Measurements
   2. Determinants
3. Income elasticity of demand
4. Cross elasticity of demand

Question 3

What are the three working definitions of price elasticity of demand?

Answer 3

1. (P/Q) x (1/slope)
2. ΔQd/ΔP
3. responsiveness of quantity demanded to change in price (i.e., price sensitivity)

Question 4

What is the equation for responsiveness of Qd to a change in P (i.e., relative change in Qd / relative change in P) ?

Answer 4

((Q2-Q1)/(Q2+Q1)/2)

((P2-P1)/(P2+P1)/2)

…

quantity difference / quantity average

price difference / price average

Question 5

Describe elasticity of equilibrium price and quantity resulting from any given shift of the supply curve.

Answer 5

The more elastic is demand, the less the change in equilibrium price and the greater the change in equilibrium quantity resulting from any given shift in the supply curve.

Question 6

Describe relatively elastic demand.

Answer 6

Question 7

Describe relatively inelastic demand.

Answer 7

Question 8

Describe the location component of elasticity.

location (i.e., position) + inclination = price elasticity of demand

Answer 8

Q is getting bigger, so P/Q is getting smaller.

Going from D1 to D2, elasticity decreases!

Question 9

Describe the inclination component of elasticity.

location (i.e., position) + inclination = price elasticity of demand

Answer 9

D2 slope is steeper than D1, but the location is the same
D2 has a lower elasticity than D1

Question 10

Describe the elasticity of these demand curves.

Answer 10

perfectly inelastic → e = 0

inelastic → e < 1

elastic → e > 1

perfectly elastic → e = ∞

unitary elasticity → e = 1

Question 11

How is price elasticity of demand affected by availabiltiy of substitutes of outputs?

Answer 11

The more/better substitutes of goods/services, the higher the elasticity.

Question 12

Compare price elasticity of demand of close substitutes with poor substitutes.

Answer 12

Question 13

How is the price elasticity of demand affected by the consumer’s budget?

Answer 13

Big-ticket items tend to have higher elasticity.

e.g., the PeD of a car will be higher than PeD of an apple

Question 14

How does time affect elasticity?

Answer 14

5. Summary

• elasticity increases over time
• Reason: over time, substitutes appear
• In the long run, all goods have substitutes

Question 15

Give examples of determinants of price elasticity of demand.

Answer 15

• Income
• Range of price
• Joint demand
• Substitutes
• Demand can be postponed or not
• Several uses of commodity
• Nature of commodity
• Money spent

Question 17

What is total revenue?

Answer 17

Price * Quantity demanded

PQ

Question 18

As the price falls on an elastic demand curve, what happens to total revenue?

Answer 18

Total revenue increases as price falls

Question 19

As the price falls on an inelastic demand curve, what happens to total revenue?

Answer 19

Total revenue decreases as price falls.

Question 20

Describe how elasticity changes along a straight line demand curve.

Answer 20

Question 21

Describe the change in total revenue and elasticity as price falls.

Answer 21

Question 22

What is the price elasticity of supply?

Answer 22

Relative change in Qs / relative change in P

I.e., price sensitivity

Responsiveness of quantity supplied to a change in price

(P/Qs) x (1/slope)

Question 23

Differentiate between relative change and percent change.

Answer 23

Relative change is the difference divided by the average; whereas, percent change is the difference divided by the initial value.

Question 24

Describe the elasticity of these supply curves.

Answer 24

Any straight line supply curve that goes thru the origin has unitary elasticity.

Question 25

Describe how availability of substitutes of inputs affects the price elasticity of supply.

Answer 25

The more/better substitutes of factors, the higher the elasticity.

Question 26

Describe the effect of time on price elasticity of supply.

Answer 26

Supply is more elastic in the long term Reason: production efficiencies keep costs down

Question 27

What is income elasticity of demand?

Answer 27

relative change in Qd / relative change in Y responsiveness of Quantity demanded to a change in income

Question 28

Describe income elastic and income inelastic.

Answer 28

Question 29

Describe the question of tax incidence.

Answer 29

Who bears the burden of the excise tax, a tax on the sale of a particular product? The burden of an excise tax is distributed between consumers and sellers in a manner that depends on the relative elasticities of supply and demand. An excise tax raises the price paid by consumers but reduces the price received by producers.

Question 30

With an excise tax, how do the consumer price and the seller price differ?

Answer 30

With an excise tax, the price paid by the consumer is p_c and the price received by the seller is p_s. The consumer price and the seller price differ by the amount of the tax, t.

Question 31

Describe income elasticity of normal goods.

Answer 31

* If income elasticity is positive but less than one, demand is income **inelastic**. * If income elasticity is positive and greater than one, demand is income **elastic**. * The more necessary an item is in the consumption pattern of consumers, the lower is its income elasticity. * Products for which the income elasticity of demand is positive but less than 1 are **necessities**. * Products for which the income elasticity of demand is positive and greater than 1 are **luxuries**.

Question 32

Describe income elasticity of inferior goods.

Answer 32

* Inferior goods have a negative income elasticity because an increase in income actually leads to a reduction in quantity demanded. * It is generally easier to find examples of inferior goods for an individual than it is for the market as a whole.

Question 33

Describe the cross elasticity of demand.

Answer 33

* Responsiveness of Qd of X to a change in P of Y. * The change in the price of good Y causes the demand curve for good X to shift. * If X and Y are substitutes, an increase in the price of Y leads to an increase in the demand for X. The demand curve for X shifts rightward. * If X and Y are complements, an increase in the price of Y leads to a decrease in the demand for X. The demand curve for X shifts leftward.

Question 34

What is an income elastic ('luxury') good?

Answer 34

When change in income leads to more than proportionate change in quantity demanded, income elasticity is greater than 1.

Question 35

What is an income inelastic ('necessity') good?

Answer 35

When change in income leads to less than proportionate change in quantity demanded, income elasticity of demand is less than 1.

Question 36

Compare the income-consumption line for normal goods and inferior goods.

Answer 36

Question 37

What determines income elasticity of demand? [3]

Answer 37

* characteristics of the good * For given level of real income the more necessary a good is, the lower the elasticity. * Necessity: e \< 1 (decrease income by 10% → decrease Qd by 5%) * Luxury: e \> 1 (decrease income by 10% → decrease Qd by 15%) * Level of consumer's income * As income rises demand shifts from necessity to luxury * Increase income → demand shifts (e.g., home to restaurant) * Reason: preferences are relative * Note on inferior goods * Inferior good = as income rises, consumer buys less

Question 38

What is the equation for cross elasticity of demand?

Question 39

Describe how the cross elasticity of demand is used to define the market.

Answer 39

Substitutes are in the same market (i.e., they are competitors) Complements are in different markets (i.e., they do not compete)