chapter 5: elasticity Flashcards
what are the assumptions of a competitive market?
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
what is price elasticity of demand?
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.
what is the most general formula for price elasticity of demand?
price elasticity of demand = % dq/ % dp
what does elastic mean?
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
what does inelastic mean?
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
what does a elastic demand curve look like?
buyers are very responsive to price and so the quantity demanded rises by a lot, therefore, the slopes will be flatter
what does an inelastic demand curve look like?
buyers are not very responsive to price, so the quantity demanded rises only by a little, therefore, the slopes are steeper
what does a vertical demand / supply curve represent?
perfectly inelastic
what does a horizontal demand/ supply curve represent?
perfectly elastic
what is the determinant of price elasticity of demand?
substitutes
the more competing products, the greater the elasticity
is demand more elastic or inelastic in the long run?
more elastic
is demand more elastic or inelastic in the short run?
more inelastic
what is the price elasticity of demand calculation recipe?
- what was the percentage change in price (using the midpoint formula)
- how much did the quantity demanded change as a percent in response? (using the midpoint formula)
- calculate the elasticity using |% dQ | / |% dP |
what is the midpoint formula?
(x2-x1)/ (average of x1 and x2) * 100
on a linear demand curve is the left or right elastic?
left
on a linear demand curve, is the left or right inelastic?
right
what is revenue?
the total amount you receive from buyers
what is the formula for revenue?
R = p * q
what happens to revenue when there is an inelastic demand?
revenue decreases as price decreases
what happens to revenue when there is elastic demand?
revenue increases as p increases
at what point is revenue maximized?
this is called unit elastic
this is the midpoint in the demand function
what is the general correlation between revenue and elasticity?
the same rise in price caused total revenue to fall in the elastic case, and rise in the inelastic case
what should a business do if there is an elastic demand?
they should lower the price of the good to increase total revenue
what should a business do if there is an inelastic demand?
they should raise the price of the good to increase total revenue
what are the other two types of demand elasticities?
- cross price elasticity of demand
- income elasticity of demand
what is cross price elasticity of demand?
a measure of how responsive the demand for one good is to price changes of another
how are complements and substitutes related goods related to the cross-price elasticity?
complements will have a negative cross price elasticity
substitutes will have a positive cross price elasticity
what is income elasticity of demand?
a measure of how responsive the demand for a good is to change in income
how are inferior and normal goods related to the income elasticity of demand?
inferior goods will have a negative income elasticity
normal goods will have a positive income elasticity
what type of elasticity do necessities have?
tend to have a small income elasticities
relatively inelastic demand
what type of elasticity do luxuries have?
tend to have a larger income elasticities
relatively elastic demand
what is price elasticity of supply?
a measure of how responsive sellers are to price changes
what is the determinant of supply?
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
