Chapter 4 Flashcards
When supply decreases, _____________
When supply decreases, the equilibrium price rises and the equilibrium quantity decreases.
If the quantity demanded is not very responsive to a change in the price, __________________
If the quantity demanded is not very responsive to a change in the price, the price rises a lot and the equilibrium quantity doesn’t change much.
If the quantity demanded is very responsive to a change in the price, ___________________
If the quantity demanded is very responsive to a change in the price, the price barely rises and the equilibrium quantity changes a lot.
If the demand curve is steep, _______________________
If the demand curve is steep, the quantity demanded of the good isn’t very responsive to a change in the price.
If the demand curve is almost flat, _____________________
If the demand curve is almost flat, the quantity demanded is very responsive to a change in the price.
Price elasticity of demand
A units-free measure of the responsiveness of the quantity demanded of a good to a change in its price, when all other influences on buyers’ plans remain the same.
Calculating Price Elasticity of Demand
Price elasticity of
demand = (Percentage change in quantity demanded) / (Percentage change in price)
Calculating Price Elasticity of Demand - Example
Refer to Word docuent for photos
Initially, the price is $20.50 a pizza and 9 pizzas an hour are demanded—the original point. The price then falls to $19.50 a pizza, and the quantity demanded increases to 11 pizzas an hour—the new point. When the price falls by $1 a pizza, the quantity demanded increases by 2 pizzas an hour.
To calculate the price elasticity of demand, we express the change in price as a percentage of the average price and the change in the quantity demanded as a percentage of the average quantity. By using the average price and average quantity, we calculate the elasticity at a point on the demand curve midway between the original point and the new point.
Average Price and Quantity
Notice that we use the average price and average quantity. We do this because it gives the most precise measurement of elasticity—at the midpoint between the original price and the new price.
If the price falls from $20.50 to $19.50, the $1 price change is 4.9 percent of $20.50. The 2 pizza change in quantity is 22.2 percent of 9 pizzas, the original quantity. So if we use these numbers, the price elasticity of demand is 22.2 divided by 4.9, which equals 4.5. But if the price rises from $19.50 to $20.50, the $1 price change is 5.1 percent of $19.50. The 2 pizza change in quantity is 18.2 percent of 11 pizzas, the original quantity. So if we use these numbers, the price elasticity of demand is 18.2 divided by 5.1, which equals 3.6.
By using percentages of the average price and average quantity, we get the same value for the elasticity regardless of whether the price falls from $20.50 to $19.50 or rises from $19.50 to $20.50.
A Units-Free Measure
Now that you’ve calculated a price elasticity of demand, you can see why it is a units-free measure. Elasticity is a units-free measure because the percentage change in each variable is independent of the units in which the variable is measured. The ratio of the two percentages is a number without units.
When the price of a good rises, the quantity demanded ________.
When the price of a good rises, the quantity demanded decreases.
Because a positive change in price brings a negative change in the quantity demanded, the price elasticity of demand is a _______ number.
Because a positive change in price brings a negative change in the quantity demanded, the price elasticity of demand is a negative number.
It is the magnitude, or absolute value, of the price elasticity of demand that tells us how responsive the quantity demanded is. So to compare price elasticities of demand, _________________________
It is the magnitude, or absolute value, of the price elasticity of demand that tells us how responsive the quantity demanded is. So to compare price elasticities of demand, we use the magnitude of the elasticity and ignore the minus sign.
Perfectly inelastic demand
Demand with a price elasticity of zero; the quantity demanded remains constant when the price changes.
One good that has a very low price elasticity of demand (perhaps zero over some price range) is insulin. Insulin is of such importance to some diabetics that if the price rises or falls, they do not change the quantity they buy.
Unit elastic demand
Demand with a price elasticity of 1; the percentage change in the quantity demanded equals the percentage change in price.
Between perfectly inelastic demand and unit elastic demand is a general case in which ____________________________
Between perfectly inelastic demand and unit elastic demand is a general case in which the percentage change in the quantity demanded is less than the percentage change in the price.
Inelastic demand
A demand with a price elasticity between 0 and 1; the percentage change in the quantity demanded is less than the percentage change in price.
Food and shelter are examples of goods with inelastic demand.
Perfectly elastic demand
Demand with an infinite price elasticity; the quantity demanded changes by an infinitely large percentage in response to a tiny price change.
An example of a good that has a very high elasticity of demand (almost infinite) is a soft drink from two campus machines located side by side. If the two machines offer the same soft drinks for the same price, some people buy from one machine and some from the other. But if one machine’s price is higher than the other’s, by even a small amount, no one buys from the machine with the higher price. Drinks from the two machines are perfect substitutes. The demand for a good that has a perfect substitute is perfectly elastic.
Between unit elastic demand and perfectly elastic demand is another general case in which ___________________
Between unit elastic demand and perfectly elastic demand is another general case in which the percentage change in the quantity demanded exceeds the percentage change in price.
Elastic demand
Demand with a price elasticity greater than 1; other things remaining the same, the percentage change in the quantity demanded exceeds the percentage change in price.
The elasticity of demand for a good depends on:
The closeness of substitutes
The proportion of income spent on the good
The time elapsed since the price change
The closer the substitutes for a good, ________________
The closer the substitutes for a good, the more elastic is the demand for it.
Oil as fuel or raw material for chemicals has no close substitutes so the demand for oil is inelastic. Plastics are close substitutes for metals, so the demand for metals is elastic.
The degree of substitutability depends on ___________
The degree of substitutability depends on how narrowly (or broadly) we define a good.
For example, a smartphone has no close substitutes, but an Apple iPhone is a close substitute for a Samsung Galaxy. So the elasticity of demand for smartphones is lower than the elasticity of demand for an iPhone or a Galaxy.
A necessity has poor substitutes, so it generally has an _______ demand.
A necessity has poor substitutes, so it generally has an inelastic demand.
A luxury usually has many substitutes, one of which is not buying it. So a luxury generally has an ______ demand.
A luxury usually has many substitutes, one of which is not buying it. So a luxury generally has an elastic demand.
Proportion of Income Spent on the Good - Other things remaining the same, the ____ the proportion of income spent on a good, the more elastic (or less inelastic) is the demand for it.
Other things remaining the same, the greater the proportion of income spent on a good, the more elastic (or less inelastic) is the demand for it.
Think about your own elasticity of demand for chewing gum and housing. If the price of gum rises, you consume almost as much as before. Your demand for gum is ______. If apartment rents rise, you look for someone to share with. Your demand for housing is not as ______ as your demand for gum.
If the price of gum rises, you consume almost as much as before. Your demand for gum is inelastic. If apartment rents rise, you look for someone to share with. Your demand for housing is not as inelastic as your demand for gum.
Why the difference? Housing takes a big chunk of your budget, and gum takes little. You barely notice the higher price of gum, while the higher rent puts your budget under severe strain.
The longer the time that has elapsed since a price change, ___________
The longer the time that has elapsed since a price change, the more elastic is demand.
When the price of oil increased by 400 percent during the 1970s, people barely changed the quantity of oil and gasoline they bought. But gradually, as more efficient auto and airplane engines were developed, the quantity bought decreased. The demand for oil became more elastic as more time elapsed following the huge price hike.
At prices above the midpoint, the price elasticity of demand is greater than 1: Demand is _______
At prices above the midpoint, the price elasticity of demand is greater than 1: Demand is elastic
At prices below the midpoint, the price elasticity of demand is less than 1: Demand is _______
At prices below the midpoint, the price elasticity of demand is less than 1: Demand is inelastic
Total revenue
The value of a firm’s sales. It is calculated as the price of the good multiplied by the quantity sold.
When a price changes, total revenue also changes.
If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent and total revenue _______.
If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent and total revenue increases.
If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent and total revenue _______.
If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent and total revenue decreases.
If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent and total revenue _______.
If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent and total revenue does not change.
Figure 4.4 info (check Word doc for figure)
In Fig. 4.4(a), over the price range $25 to $12.50 a pizza, demand is elastic. At a price of $12.50 a pizza, demand is unit elastic. Over the price range from $12.50 a pizza to zero, demand is inelastic.
Figure 4.4(b) shows total revenue. At a price of $25, the quantity sold is zero, so total revenue is zero. At a price of zero, the quantity demanded is 50 pizzas an hour and total revenue is again zero. A price cut in the elastic range brings an increase in total revenue—the percentage increase in the quantity demanded is greater than the percentage decrease in price. A price cut in the inelastic range brings a decrease in total revenue—the percentage increase in the quantity demanded is less than the percentage decrease in price. At unit elasticity, total revenue is at a maximum.
Figure 4.4 shows how we can use this relationship between elasticity and total revenue to estimate elasticity using the total revenue test. The total revenue test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price, when all other influences on the quantity sold remain the same.
Total revenue test
A method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price, when all other influences on the quantity sold remain the same.
Elasticity
The degree to which demand or supply reacts to a change in price
If your demand for the good is elastic, a 1 percent price cut increases the quantity you buy by more than 1 percent and your expenditure on the item _______.
If your demand for the good is elastic, a 1 percent price cut increases the quantity you buy by more than 1 percent and your expenditure on the item increases.
If your demand for the good is inelastic, a 1 percent price cut increases the quantity you buy by less than 1 percent and your expenditure on the item ________.
If your demand for the good is inelastic, a 1 percent price cut increases the quantity you buy by less than 1 percent and your expenditure on the item decreases.
If your demand for the good is unit elastic, a 1 percent price cut increases the quantity you buy by 1 percent and your expenditure on the item _______.
If your demand for the good is unit elastic, a 1 percent price cut increases the quantity you buy by 1 percent and your expenditure on the item does not change.
If you spend more on an item when its price falls, your demand for that item is ______; if you spend the same amount, your demand is __________; and if you spend less, your demand is _______.
If you spend more on an item when its price falls, your demand for that item is elastic; if you spend the same amount, your demand is unit elastic; and if you spend less, your demand is inelastic.
Income elasticity of demand
The responsiveness of demand to a change in income, other things remaining the same. It is calculated as the percentage change in the quantity demanded divided by the percentage change in income.
Income elasticities of demand can be positive or negative and they fall into three interesting ranges:
Positive and greater than 1 (normal good, income elastic)
Positive and less than 1 (normal good, income inelastic)
Negative (inferior good)
Income Elastic Demand - example
Suppose that the price of pizza is constant and 9 pizzas an hour are bought. Then incomes rise from $975 to $1,025 a week. No other influence on buying plans changes and the quantity of pizzas sold increases to 11 an hour.
The change in the quantity demanded is +2 pizzas. The average quantity is 10 pizzas, so the quantity demanded increases by 20 percent. The change in income is +$50 and the average income is $1,000, so incomes increase by 5 percent. The income elasticity of demand for pizza is
20%/5% = 4
The demand for pizza is income elastic. The percentage increase in the quantity of pizza demanded exceeds the percentage increase in income.
(Income Inelastic Demand)
If the income elasticity of demand is positive but less than 1, demand is income ______.
If the income elasticity of demand is positive but less than 1, demand is income inelastic.
The percentage increase in the quantity demanded is positive but less than the percentage increase in income.
If the demand for a good is income elastic, the percentage of income spent on that good increases as income ______.
If the demand for a good is income elastic, the percentage of income spent on that good increases as income increases.
If the demand for a good is income inelastic, the percentage of income spent on that good decreases as income ________.
If the demand for a good is income inelastic, the percentage of income spent on that good decreases as income increases.
Economics in Action Income Elastic and Inelastic Demand - information
Necessities such as food or clothing is income inelastic, while the demand for a luxury such as airline travel is income elastic.
Inferior Goods
If the income elasticity of demand is negative, the good is an inferior good.
The quantity demanded of an inferior good and the amount spent on it decrease when income ______.
The quantity demanded of an inferior good and the amount spent on it decrease when income increases.
Goods in this category include small motorcycles, potatoes, and rice. Low-income consumers buy these goods and spend a large percentage of their incomes on them.
Cross elasticity of demand
The responsiveness of the demand for a good to a change in the price of a substitute or complement, other things remaining the same. It is calculated as the percentage change in the quantity demanded of the good divided by the percentage change in the price of the substitute or complement.
If the cross elasticity of demand is positive, demand and the price of the other good change in __________, so the two goods are substitutes.
If the cross elasticity of demand is positive, demand and the price of the other good change in the same direction, so the two goods are substitutes.
If the cross elasticity of demand is negative, demand and the price of the other good change in ________, so the two goods are complements.
If the cross elasticity of demand is negative, demand and the price of the other good change in opposite directions, so the two goods are complements.
Substitutes - example
Suppose that the price of pizza is constant and people buy 9 pizzas an hour. Then the price of a burger rises from $1.50 to $2.50. No other influence on buying plans changes and the quantity of pizzas bought increases to 11 an hour.
The change in the quantity demanded at the current price is +2 pizzas—the new quantity, 11 pizzas, minus the original quantity, 9 pizzas. The average quantity is 10 pizzas. So the quantity of pizzas demanded increases by 20 percent.
The change in the price of a burger, a substitute for pizza, is +$1—the new price, $2.50, minus the original price, $1.50. The average price is $2 a burger. So the price of a burger rises by 50 percent.
So the cross elasticity of demand for pizza with respect to the price of a burger is 0.4
Complements - example
Now suppose that the price of pizza is constant and 11 pizzas an hour are bought. Then the price of a soft drink rises from $1.50 to $2.50. No other influence on buying plans changes and the quantity of pizzas bought falls to 9 an hour.
The change in the quantity demanded is the opposite of what we’ve just calculated: The quantity of pizzas demanded decreases by 20 percent (−20%).
The change in the price of a soft drink, a rise of $1 from $1.50 to $2.50, is the same as the change in the price of a burger that we’ve just calculated. That is, the price rises by 50 percent (+50%).
So the cross elasticity of demand for pizza with respect to the price of a soft drink is -0.4
Because pizza and soft drinks are complements, when the price of a soft drink rises, the demand for pizza decreases.
Because a rise in the price of a substitute brings an increase in the demand for good, the cross elasticity of demand for a good with respect to the price of a substitute is _______.
Both the price and the quantity change in _______ direction(s).
Because a rise in the price of a substitute (burger) brings an increase in the demand for good (pizza), the cross elasticity of demand for good with respect to the price of a substitute is positive.
Both the price and the quantity change in the same direction.
Because a rise in the price of a complement brings a decrease in the demand for a good, the cross elasticity of demand for a good with respect to the price of a complement is ______.
The price and quantity change in _______ direction(s).
Because a rise in the price of a complement (soft drink) brings a decrease in the demand for pizza (a good), the cross elasticity of demand for pizza with respect to the price of a soft drink is negative.
The price and quantity change in opposite directions.
The magnitude of the cross elasticity of demand determines how far the demand curve shifts. The larger the cross elasticity (absolute value), the _____ is the change in demand and the larger is the shift in the demand curve.
The magnitude of the cross elasticity of demand determines how far the demand curve shifts. The larger the cross elasticity (absolute value), the greater is the change in demand and the larger is the shift in the demand curve.
If two items are close substitutes, such as two brands of spring water, the cross elasticity is _____. If two items are close complements, such as movies and popcorn, the cross elasticity is ______.
If two items are close substitutes, such as two brands of spring water, the cross elasticity is large. If two items are close complements, such as movies and popcorn, the cross elasticity is large.
If two items are somewhat unrelated to each other, such as newspapers and orange juice, the cross elasticity is _______.
If two items are somewhat unrelated to each other, such as newspapers and orange juice, the cross elasticity is small—perhaps even zero.
If the quantity supplied is not very responsive to price, then an increase in demand brings a large rise in the price and a _____ increase in the equilibrium quantity.
(Elasticity of Supply)
If the quantity supplied is not very responsive to price, then an increase in demand brings a large rise in the price and a small increase in the equilibrium quantity.
If the quantity supplied is highly responsive to price, then an increase in demand brings a small rise in the price and a ______ increase in the equilibrium quantity.
(Elasticity of Supply)
If the quantity supplied is highly responsive to price, then an increase in demand brings a small rise in the price and a large increase in the equilibrium quantity.
Elasticity of supply
The responsiveness of the quantity supplied of a good to a change in its price, other things remaining the same.
If the elasticity of supply is greater than 1, we say that supply is ______; and if the elasticity of supply is less than 1, we say that supply is ______.
If the elasticity of supply is greater than 1, we say that supply is elastic; and if the elasticity of supply is less than 1, we say that supply is inelastic.
Elasticity of supply - example
Suppose that when the price rises from $20 to $21, the quantity supplied increases from 10 to 20 pizzas per hour. The price rise is $1 and the average price is $20.50, so the price rises by 4.9 percent of the average price. The quantity increases from 10 to 20 pizzas an hour, so the increase is 10 pizzas, the average quantity is 15 pizzas, and the quantity increases by 67 percent. The elasticity of supply is equal to 67 percent divided by 4.9 percent, which equals 13.67. Because the elasticity of supply exceeds 1 (in this case by a lot), supply is elastic.
In contrast, suppose that when the price rises from $20 to $30, the quantity of pizza supplied increases from 10 to 13 per hour. The price rise is $10 and the average price is $25, so the price rises by 40 percent of the average price. The quantity increases from 10 to 13 pizzas an hour, so the increase is 3 pizzas, the average quantity is 11.5 pizzas an hour, and the quantity increases by 26 percent. The elasticity of supply is equal to 26 percent divided by 40 percent, which equals 0.65. Now, because the elasticity of supply is less than 1, supply is inelastic.
The elasticity of supply of a good depends on two things
The Factors That Influence the Elasticity of Supply
Resource substitution possibilities
Time frame for the supply decision
To study the influence of the amount of time elapsed since a price change, we distinguish three time frames of supply: (three things)
(Time Frame for the Supply Decision)
Momentary supply
Short-run supply
Long-run supply
Momentary Supply - information
When the price of a good changes, the immediate response of the quantity supplied is determined by the momentary supply of that good.
Momentary Supply - inelastic example
Some goods, such as fruits and vegetables, have a perfectly inelastic momentary supply—a vertical supply curve. The quantities supplied depend on crop-planting decisions made earlier. In the case of oranges, for example, planting decisions have to be made many years in advance of the crop being available. Momentary supply is perfectly inelastic because, on a given day, no matter what the price of oranges, producers cannot change their output. They have picked, packed, and shipped their crop to market, and the quantity available for that day is fixed.
Momentary supply - elastic example
In contrast, some goods have a perfectly elastic momentary supply. Long-distance phone calls are an example. When many people simultaneously make a call, there is a big surge in the demand for telephone cables, computer switching, and satellite time. The quantity supplied increases, but the price remains constant. Long-distance carriers monitor fluctuations in demand and reroute calls to ensure that the quantity supplied equals the quantity demanded without changing the price.
Short-Run Supply - info
The response of the quantity supplied to a price change when only some of the possible adjustments to production can be made is determined by short-run supply. Most goods have an inelastic short-run supply.
To increase output in the short run, firms must work their labour force overtime and perhaps hire additional workers.
To decrease their output in the short run, firms either lay off workers or reduce their hours of work.
With the passage of time, firms can make more adjustments, perhaps training additional workers or buying additional tools and other equipment.
Short-run supply - orange grower example
For the orange grower, if the price of oranges falls, some pickers can be laid off and oranges left on the trees to rot. Or if the price of oranges rises, the grower can use more fertilizer and improved irrigation to increase the yield of the existing trees.
But an orange grower can’t change the number of trees producing oranges in the short run.
Long-Run Supply - info
The response of the quantity supplied to a price change after all the technologically possible ways of adjusting supply have been exploited is determined by long-run supply. For most goods and services, long-run supply is elastic and perhaps perfectly elastic.
Long-Run Supply - orange grower example
For the orange grower, the long run is the time it takes new tree plantings to grow to full maturity—about 15 years. In some cases, the long-run adjustment occurs only after a completely new production plant has been built and workers have been trained to operate it—typically a process that might take several years.
