Chapter 4: Elasticity

Question 1

RECAP: as supply decreases, equilibrium price _____ & equilibrium quantity ______.

Answer 1

1. Rises
2. Decreases

Question 2

What occurs if the quantity demanded is not responsive to change in price?

Answer 2

price rises a lot & equilibrium quantity doesn’t change much
Inelastic - insensitive to price change
E.g. things w/o substitutes or complements (gas)

Question 3

what occurs when quantity demanded is very responsive to change in price?

Answer 3

price barely rises & equilibrium quantity changes a lot
Elastic - usually things w/ substitutes or complements

Question 4

What is price elasticity of demand?

Answer 4

units-free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same

Question 5

Describe how to calculate price elasticity of demand

Answer 5

Price elasticity of demand = percentage change in quantity demanded/percentage change in price

1st calculate percentage change in price

Then calculate % change in quantity demanded (same as above except w/ quantity

find price elasticity of demanded take product of both equations above & divide them

Question 6

Perfectly inelastic demand

Answer 6

quantity demanded = 0 when the price changes; price elasticity of demand is 0
○ E.g. Insulin - regardless of price, quantity bought does not change
Vertical graph

Question 7

Unit elastic demand

Answer 7

% change in the quantity demanded = % change in price
○ Elasticity = 1

Question 8

Inelastic demand

Answer 8

% change in quantity demanded is < the % change in price
○ Elasticity between 0 & 1
○ E.g. food & housing

Question 9

Perfectly elastic demand

Answer 9

quantity demanded changes by an infinitely large % in response to tiny price change
○ Elasticity = infinity
○ E.g. campus has 2 vending machines with drinks for same price (doesn’t matter where its bought from)
- However, if one machine increases price, people will stop buying from that one & go to the other (substitute)

Question 10

Elastic Demand

Answer 10

% change in the quantity demanded exceeds % change in price
○ Elasticity = greater than 1
E.g. streamed movies & music

Question 11

what 3 factors influence elasticity of demand?

Answer 11

1. Closeness of substitute - closer the substitute for a good, more elastic the demand
   E.g. oil has no close substitutes so demand is inelastic
   E.g. Plastic is a close substitute for metal so demand is elastic
   Necessities have poor substitutes (inelastic); Luxuries have many (elastic)
2. Proportion of income spend on good - greater the proportion, the more elastic is the demand for it
3. Longer the time has elapsed since a price change the more elastic the demand

Question 12

What is total revenue?

Answer 12

from the sale of a good = the price of the good multiplied by the quantity sold
When price changes, total revenue changes
Cut in price doesn’t always decrease total revenue
Change in total revenue depends on elasticity of demand

Question 13

What is the total revenue test?

Answer 13

method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price

○ Price cut increases total revenue - elastic
○ Price cut decreases total revenue - inelastic
○ Price cut leaves total revenue unchanged - unit elastic

Question 14

What is income elasticity of demand?

Answer 14

measure of the responsiveness of the demand for a good/service to a change in income, other things remaining the same
Tells us how much a demand curve shifts at a given price

Question 15

what is the formula for income elasticity of demand & what outcomes do we receive from it?

Answer 15

Income elasticity of demand = percentage change in quantity demanded/percentage change in income
○ + & greater than 1 (normal good, income elastic)
○ + & less than 1 (normal good, income inelastic)
○ -tve (inferior good)

Question 16

What is cross elasticity of demand?

Answer 16

measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement

If +, demand & price of the other good change in the same direction (substitutes)

If -, demand & price of the other good change in opposite direction (complements

Formula:
Cross elasticity of demand = % change in quantity demanded/ % change in price of a substitute or complement

Question 17

What is elasticity of supply?

Answer 17

measures the responsiveness of the quantity supplied to a change in the price of a good
Elasticity of Supply = % change in quantity suppled/ % change in price
§ Greater than 1, elastic
Less than 1, inelastic

Question 18

Describe the types of elasticity of supply

Answer 18

Perfectly Inelastic - quantity supplied is fixed regardless of price
Curve is vertical & elasticity of supply is 0

Unit Elastic - % change in price = % change in quantity
Linear & passes through point of origin

Perfectly Elastic - price at which sellers are willing to offer an quantity for sale
Curve is horizontal; elasticity of supply is infinite

Question 19

What are the 3 time frames for supply decisions?

Answer 19

○ Momentary Supply - price of a good changes, the immediate response of the quantity supplied is determined by this time frame
○ Short-Run Supply -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
○ Long-Run Supply - response of the quantity supplied to a price change after all the technologically possible ways of adjusting supply have been exploited