Chapter 6 Flashcards
elasticity
- a measure of responsiveness to changes in prices or incomes
price elasticity of demand
- ratio of the percent change in quantity demanded to the percent change in price as we move along the demand curve (drop minus sign)
% Change in quantity demanded
% change in price
% change in quantity demanded
Change in quantity demanded
Initial quantity demanded X 100
% Change in Price
Change in price
Initial Price X 100
Highly elastic
- when price of elasticity of demand is large
- when quantity demanded is changed by a large percentage compared to the percent change in price
Inelastic demand
- a small price elasticity
- ex. 0.2
- The quantity demanded will fall by a relatively small amount when price rises
Midpoint Method
- a technique for calculating the percent change
% change in X = Change in X
Average value of x X 100
Average value of X
Starting value of X + Final value of X
2
Computing Price elasticy of demand with 2 points
Q2 - Q1
(Q1 + Q2) / 2
P2 - P1
(P1 + P2) / 2
Examples of goods that have inleastic demand
- eggs 0.1
- Beef 0.4
- Stationery 0.5
- Gasoline 0.5
Examples of goods with Elastic demand
- Housing 1.2
- Restaurant meals 2.3
- Airline travel 2.4
- Foreign travel 4.1
Perfectly inelastic demand
- When the quantity demanded does not respond at all to changes in price
- demand curve is a vertical line
- price elasticity of demand = 0
Perfectly elastic
- When any price increase will cause the quantity demanded to drop to zero
- Demand curve is a horizontal lie
- price elasticity of demand = infinite
- if it goes below the horizontal line, people will be an an extremely large number of item
Elastic
- if the price elasticity of demand is greater than 1
Inelastic
- If the price elasticity of demand is less than 1
Unit elastic
- if the price elasticty of demand is exactly 1
Total revenue
- Price x Quantity sold
- price elasticity of demand affects the total revenue of a good
How to calculate total revenue on a graph
- Total revenue is equal to the area of a rectangle whoe height is the price and whose width is the quantity demanded at that price
When a seller raises a price, 2 things happen:
- price effect
- quantity effect
Price effect
- After a price increase, each unit sold sells at a higher price, which tends to raise revenue
Quantity effect
- After a price increase, fewer units are sold, which tends to lower revenue
IF demand for a good is unit-elastic
- price elasticity of demand is 1
- an increase in price does not change total revenue
- quantity effect and the price effect exactly offset each other
If demand for a good is inelastic
- elasticity < 1
- a higher price increases total revenue
- price effect is stronger than the quantity effect
If demand for a good is elastic
- elasticity > 1
- increase in price reduces total revenue
- quantity effect is stronger than the price effect
If demand is unit-elastic and price goes down, then
There is no effect on total revenue
When demand is inelastic and price falls, then
Total revenue decreases
When demand is elastic and price falls, then
increases total revenue
Four main factors that determine elasticity:
- Whether close substitutes are available
- high elasticity if there are substitutes
- Whether the good is a necessity or a luxury
- if luxury then highly elastic
- Share of income spent on the good
- If large share of income then highly elastic
- Time
- Over time elasticity will go up
In particular, why do demand curves shift?
- changes in prices of related goods
- changes in in consumer’s incomes
Cross-price elasticity of demand
- measures the effect of the change in one good’s price on the quantity demanded of the other good
% change in quantity of A demanded
% change in price of B
If two goods are close substitutes, there cross-price elasticity will be:
positive and large
If two goods are not close substitutes, there cross-price elasticity will be:
positive and small
When two goods are complements, the cross-price elasticity is…
negative
If the cross-price elasticity is very negative, then…
they are strong complements
If the cross-price elasticity is only slightly below zero, then….
they are weak complements
True or false: signs are important for cross-price elasticity of demand.
True
- means complements
+ means substitutes
income elasticity of demand
% change in quantity demanded
% change in income
If income elasticity of demand is positive
the good is a normal good
If income elasticity of demand is negative
the good is an inferior good
income-elastic
- if the income elasticity of demand is greater than 1
income-inelastic
- if the income elasticity of demand is positive but less than 1
- ex. food and cloothing
Price elasticity of supply
% change in quantity supplied
% change in price
Perfectly inelastic supply
- when the price elasticity of supply is zero
- changes in the price of the good have no effect on quantity supplied
- vertical line
Perfectly elastic supply
- when a tiny increase or reduction in the price will lead to very large changes in the quantity supplied
- price elasticity of suplly is infinite
- horizontal line
2 determinants of the price elasticity of supply:
- Availability of inputs
- price elasticity is large when inputs are readily available
- Time
- price elasticity of supply grows as producers have more time
