chapter 5: elasticity

Question 1

what are the assumptions of a competitive market?

Answer 1

consumers are price takers

producers/ firms are suppliers. there are many firms selling homogeneous goods, and each firm is small relative to the market demand

Question 2

what is price elasticity of demand?

Answer 2

a measure of how responsive buyers are to price changes. it measures the percent change in quantity demanded that follows from a 1% price change.

Question 3

what is the most general formula for price elasticity of demand?

Answer 3

price elasticity of demand = % dq/ % dp

Question 4

what does elastic mean?

Answer 4

when the absolute value of the percent change in quantity is larger than the absolute value of the percent change in the price (abs value of the price elasticity is greater than 1)

means the buyer is more responsive to changes in price

a person who has more substitutes for a good/ service is elastic

Question 5

what does inelastic mean?

Answer 5

when the absolute value of the percent change in quantity is smaller than the absolute value of the percent change in price (abs value of the price elasticity is less than 1)

means the buyer is not responsive to changes in price because they don’t have substitutes present

Question 6

what does a elastic demand curve look like?

Answer 6

buyers are very responsive to price and so the quantity demanded rises by a lot, therefore, the slopes will be flatter

Question 7

what does an inelastic demand curve look like?

Answer 7

buyers are not very responsive to price, so the quantity demanded rises only by a little, therefore, the slopes are steeper

Question 8

what does a vertical demand / supply curve represent?

Answer 8

perfectly inelastic

Question 9

what does a horizontal demand/ supply curve represent?

Answer 9

perfectly elastic

Question 10

what is the determinant of price elasticity of demand?

Answer 10

substitutes

the more competing products, the greater the elasticity

Question 11

is demand more elastic or inelastic in the long run?

Answer 11

more elastic

Question 12

is demand more elastic or inelastic in the short run?

Answer 12

more inelastic

Question 13

what is the price elasticity of demand calculation recipe?

Answer 13

1. what was the percentage change in price (using the midpoint formula)
2. how much did the quantity demanded change as a percent in response? (using the midpoint formula)
3. calculate the elasticity using |% dQ | / |% dP |

Question 14

what is the midpoint formula?

Answer 14

(x2-x1)/ (average of x1 and x2) * 100

Question 15

on a linear demand curve is the left or right elastic?

Answer 15

left

Question 16

on a linear demand curve, is the left or right inelastic?

Answer 16

right

Question 17

what is revenue?

Answer 17

the total amount you receive from buyers

Question 18

what is the formula for revenue?

Answer 18

R = p * q

Question 19

what happens to revenue when there is an inelastic demand?

Answer 19

revenue decreases as price decreases

Question 20

what happens to revenue when there is elastic demand?

Answer 20

revenue increases as p increases

Question 21

at what point is revenue maximized?

Answer 21

this is called unit elastic

this is the midpoint in the demand function

Question 22

what is the general correlation between revenue and elasticity?

Answer 22

the same rise in price caused total revenue to fall in the elastic case, and rise in the inelastic case

Question 23

what should a business do if there is an elastic demand?

Answer 23

they should lower the price of the good to increase total revenue

Question 24

what should a business do if there is an inelastic demand?

Answer 24

they should raise the price of the good to increase total revenue

Question 25

what are the other two types of demand elasticities?

Answer 25

• cross price elasticity of demand
• income elasticity of demand

Question 26

what is cross price elasticity of demand?

Answer 26

a measure of how responsive the demand for one good is to price changes of another

Question 27

how are complements and substitutes related goods related to the cross-price elasticity?

Answer 27

complements will have a negative cross price elasticity
substitutes will have a positive cross price elasticity

Question 28

what is income elasticity of demand?

Answer 28

a measure of how responsive the demand for a good is to change in income

Question 29

how are inferior and normal goods related to the income elasticity of demand?

Answer 29

inferior goods will have a negative income elasticity
normal goods will have a positive income elasticity

Question 30

what type of elasticity do necessities have?

Answer 30

tend to have a small income elasticities

relatively inelastic demand

Question 31

what type of elasticity do luxuries have?

Answer 31

tend to have a larger income elasticities

relatively elastic demand

Question 32

what is price elasticity of supply?

Answer 32

a measure of how responsive sellers are to price changes

Question 33

what is the determinant of supply?

Answer 33

flexibility

inventories make supply more elastic

easily available variable inputs make supply elastic

extra capacity makes supply elastic

easy entry and exist make supply more elastic

over time, supply becomes more elastic