Chapter Three Flashcards
Law of demand
Inverse relationship between price and quantity demanded—negative slope
Market
Brings together buyers and sellers
Determinants of demand
1) Change in Taste
2) Amount of buyers
3) Income of buyers
4) Prices of related goods
5) Consumer expectations
Lead to movement of the curve
Changes in the quantity of demand
Movement of the point
Law of supply
Direct relationship–positive slope
Determinants of supply
1) Resource prices
2) Technology
3) Taxes and subsidies
4) Prices of other goods
5) Producer expectations
6) Number of sellers
Equilibrium price
Intentions of buyers and sellers match
Supply=demand
Allocative efficiency
Mix of goods and services most highly valued by society
How does the equilibrium price change if the supply increases and the demand increases?
The supply increasing would drop the equilibrium price the demand rising would boost it so it would stay roughly the same
If both the supply and demand decrease what will happen to the equilibrium price?
It will fall
Decrease in supply
Increases equilibrium price and reduces the equilibrium quantity
Increase in demand
Boosts both the equilibrium price and quantity
Price ceiling
A line underneath the equilibrium in order to help consumers. It leads to a shortage
Price Floor
Line above the equilibrium to help suppliers and leads to a surplus
Do price floors and ceilings change supply and demand?
NO
Tax Supply Demand Graph
Supply shifts in
Both consumers and producers lose
Deadweight loss
Government takes center rectangle for taxes (tax revenue)
Price elasticity of demand
Responsiveness of consumers to a price change is meadured by a product’s price elasticity of demand
Elastic
When price changes cause large changes in the quantity purchased
Inelastic
When there is not a real change in quantity purchased due to a price change
Ed=
% change in quantity demanded of product X/ % change of price of product X
Will always be negative—–absolute value
Midpoint formula
Ed= change in quantity/sum of quantities/2
Ed>1
Elastic
Ed<1
Inelastic
Ed=1
Unit elastic
Perfectly inelastic
Absolutely no consumer response, Ed=0
Vertical demand
Perfectly elastic
Ed=infinity
Horizontal demand
Total Revenue
TR=P*Q
If demand is elastic, decrease in price will increase TR (inverse)
If demand is inelastic, decrease in price will decrease the TR (direct)
Unit elastic= no change in TR
Elasticity along a demand curve
Depends on the location of the point…differs throughout curve
Determinants of Ed
1) Substitutability–more substitutes=more elasticity
2) Proportion of income
3) Luxuries or necessities?
4) Time
Price elasticity of supply
Es= % change in quantity supplied/ % change in price
degree of price elasticity of supply depends on how easily producers can shift resources for alternative use
Immediate market period
length of time over which producers are unable to respond to a change in price with a change in quantity
Short run (microeconomics)
Period of time too short to change plant capacity but long enough to use the fixed size plant more or less intensely
Long run
Time period long enough to adjust plant size
Cross elasticity of demand
how sensitive consumer purchases of one product are to a change in the price of another product (for understanding complementary goods)
Exy= % change in quantity demanded of X/ % change in price of product y
if + then substitutes
if - then complements
if 0 then unrelated
Income elasticity of demand
measures the degree to which consumers respond to a change in income by buying more or less of a good
Ei= % changed in quantity demanded/ % change in income
Normal= Ei= + Inferior= Ei= -
TR and elasticity
Rubber band
Price and TR move in opposite directions
TR and inelasticity
Pencil
Price and TR move in the same direction
Determinants of elasticity of supply
Time period
Long period
Elastic
Horizontal elasticity of supply
more elastic
Vertical elasticity of supply
more inelastic
Taxes with relatively inelastic versus elastic demand (same tax/shift in supply)
Elastic has more deadweight loss
Consumers pay more tax when demand is inelastic
Producers pay more with elastic
More tax revenue with relatively inelastic demand
If price falls and demand is inelastic then TR
decreases
Price rises and demand is elastic then TR
decreases
Price rises and supply is elastic then TR
increases
Price rises and supply is inelastic then TR
increases
Price rises and demand is inelastic TR
increases
Price falls and demand is elastic then TR
increases
Price falls and demand is unit elastic TR
is unchanged
A downward sloping demand curve can be explained by
Diminishing marginal utility
the substitution effect
the income effect
Quantity demanded is a
shift of the point
Demand is a
shift in the curve
Elasticity questions
p and q move in opposite directions
if TR remains constant
unit elastic
The substitution effect causes a consumer to buy less of a product when the price increases because the
product is now more expensive compared to similar products
