EC1101E part 3 Flashcards
What is elasticity?
measure of
the responsiveness of Q D or Q S
to one of its determinants
(price, price of a related good, income).
What is the definition of price elasticity of demand
measures
how much Q D responds to a change in P
price sensitivity of buyers’ demand
elastic : >1
inelastic: <1
How does the price elasticity of demand relate to the slope of demand curve?
closely related to slope of demand curve
Ped x (p/q) where p and q is the point you are trying to find ped at
What is the price percectly inelastic demnad?
- vertical
- 0 (cause 0/ any change in quantity0
What is the curve for perfectly elasticv demand and value?
horizontal
infinity( any change in q/ 0 change in price)
Blue jeans vs clothing
The prices of both goods rise by 20%. Which good has a bigger fall in Q D ? Why?
Blue jeans
price elasticity of demand is greater for narrowly defined goods
than for broadly defined ones.
Why does revenue decrease when price increase as demand is elastic/
PED >1
consumers a price sensitive, are very responsive, the change in quantity is going to be larger than the change in price
fall in revenue from a lower q dominates the rise in revenue form a higher P
so revenue falls
Why did luxury brands like Chanel, Louis Vuitton, and Gucci raise their prices in the first half of 2020?
- Raissing prices beyond the increase in cost
- Companies’ objectives is to maximise profit = TR- TC
- TR= Price per quantity * quantity
- Believe that by doing so when increase price, they are increasing revenue and thus profit, and they know that PED inelastic, as change in quatntiy isnt as much
- Price effect will dominate, as quantity decreases less than proportionately
- Veblem good (valuation of good depends on price of good)
What is cross price elasticity of demand?
measures how much Q D responds to a change in the price of another good.
- substitutes: >0
- complements: <0
What is income elasticity of demand?
State what ranges of its values mean
measures how much Q D responds to a change in income.
normal good: >0
inferior good: <0
NOTE: INCOME IS THE THING THAT CHANGES FIRST !!!!
What is price elasticity of supply?
measures how much Qs resonds to a change in P
measures the price-sensitivity of sellers’ supply
When is price elasticity of supply always 1 on any point on graph?
SUPPLY CURVE PASS THROUGH ORIGIN
What is the price elasticity of vertical supply curve?
0
change in Q: 0
Change in price: any
How does the graph for infinite PES look like?
Horizontal
Change in Q: any
Change in P: 0
What are the determinants of supply elasticity?
ease of change in quantity
long run vs short run
How does products that are easy to produce change PES?
more easily sellers can change the quantity they produce,
the greater the price elasticity of supply
Explain how long run vs short rrun affect PES?
For many goods, the price elasticity of supply is greater in the long run than in the short run because firms can build new factories, or new firms may be able to enter the market.
Suppose the price elasticity of demand of widgets is 2. A price decrease causes revenue to _____.
INCREASE
Suppose the price elasticity of supply of bidgets is 0.3. A decrease in demand has a bigger impact on
______ than on ______
price
quantity supplied
What is welfare economcis?
how the allocation of resources affects economic well-being.
What does allocation of resource refer to?
- how much of each good and service is produced
- which producers produce them
- which consumers consume them
What is willingness to pay?
maximum amount
the buyer will pay for that good.
measure of benefit/value of good
When will buyers buy a good?
if his willingness to pay (WTP)
is at least as high as the price
What does the horizontal line in the staircase demand curve represent?
willingness to pay
What does the height of the demadn curve in stari case model represent
WTP of the
marginal buyer
— the buyer who
would leave the market if P were any higher.
what is the martginal buyer ?
Buyer who would leave the market if P were any higher
will drop out of the market if price rises even by a bit
What is consumer surplus?
amount a buyer is willing to pay minus the amount he actually pays
buyers’ gains from participating in the market
Imagine a demand curve where price rises, why does consumer surplus fall?
- quantity demanded decreases, fall in CS due to the buyers leaving market
- Rise in price causes the CS to decrease, as remaining buyers pay higher price P[
What is cost?
MEASURE OF WILLINGNESS TO SELL
value of everything a seller must give up to produce a good
including cost of inputs and value of sellers’ time
When will seller produce the good, in terms of benefits and cost
Cost benefit analysis
If benefit is AT LEAST AS HIGH as cost of producing good, then seller would sell the good
What does the height of the supply curve represent in staircase supply curve/
cost of the marginal seller— the seller who would leave
the market if
the price were any lower due to not being profitable to produce that unit of good
What is the marginal seller?
— the seller who would leave
the market if
the price were any lower.
What is producer surplus?
amount a seller is paid for a good minus the cost
area above the S curve, below the price, from 0 to Q
seller gains from participating in market
Explain what happens to producer surplus when the price DECREASE?
decrease in QS causes the fall in PS due to sellers leaving the market
Additional fall in PS due to the sellers remaining in market getting the lower price(getting less for each good sold)
How to answer whether a market allocation of resources is desirable? Or whether society would be better off with diff allocation of resources?
use total surplus as a measure of society’s well-being, and we consider whether the market’s allocation is efficient.
When is allocation of resources efficienmt?>
maximises total surplus
What does efficiency mean?
- The goods are consumed by
the buyers who value them most highly. - The goods are produced by the sellers with the lowest cost.
- maximise surplus
Less impt
- (esp when perfect competition where seller and buyer are price takers??)
- (if there exist market prices for these goods, and assuming no externalities)
The Market equilibrium is efficient.
True or False/
FALSE
N REALITY HAVE EXTERNALITIES
The government cannot raise total surplus by changing ht market’s allocation of resources.
True or False
False
Governemnt can increase surplus
What does efficiency in PERFECTLY COMPETITIVE MARKET MEAN?
- Companies making things the right way.
- Companies making the right things.
- Things being made in the right proportions.
- Things going to the “right” people.
What does “Right “ people mean/
- Demand= willing and able to buy something
- But sometimes, people don’t have the ability to pay for the good
- REFERRING TO SOMEONE WHO IS WILLING AND ABLE OT BUY THE GOOD
Which buyers will consume the good?
The buyers
with the highest valuation are the ones
who consume the good.
after comparing cost and benefits
Which sellers will produce the good?
The sellers
with the lowest cost are the ones
who produce the good
After comparing cost and benefits
Why does a quantity greater than the eqm not maximise total surplus?
Cost greater than the value, hence, too many goods in the market, hence can increase surplus by dropping quantity
What does invisible hand mean?
- if markets are perfectly competitive
- buyers and sellers are free to act on their own
- Each buyer and seller pursue own interest, and act on their own
- outcome that is efficeint, where total surplus is maximised
What does eqm price reflect when it is reached through invisible hands?
- the buyer’s valuation of the good and
- the seller’s cost of producing the good.
- interaction of buyers and sellers determines prices
- Prices guide self-interested households and firms to allocate resources such that
society’s well-being is maximized.
Are market equilibrium efficient in perfect comp? Why?
FALSE
-necessary but insufficient condition for market efficiency
Need all of first fundamental, theorem before it can happen
Why are centrally-planned economies inefficint?
- To allocate resources efficiently and maximize total surplus, the central planner would need to know
every seller’s cost and
every buyer’s WTP
for every good in the entire economy.
State the first fundamental theorem of welfare economics?
Assume that:
- There are markets and market prices for all goods. (many goods and many market prices)
- All buyers and sellers are competitive price-takers.
- Each person’s utility depends only on his own consumption.
MARKET EQUILIBRIUM IS EFFICIENT
They are assumptions!!!,!
How does the first fundamental theorem of welfare economics fail?
Utility depends on decisions of other people as well (externalities)
in real world markets not perfectly competitive(market power)
A college student eats instant noodles twice a week and earns $300 a week working part time. After graduating, he now earns $1,000 a week and eats instant noodles once every other week. What is his income elasticity of demand for instant noodles?
-0.90
-1.11
-1.62
-0.62
-0.32
-1.11 (use the midpooint method!!!)
n the 1990s, reformers went to Sudan to buy slaves and set them free. What happened to the demand curve and the supply curve in the market for slaves?
The supply curve shifted left.
The demand curve shifted right.
The demand curve shifted left.
The supply curve shifted right.
The demand curve shifted right.
Inefficiency exists in an economy when a good is
I. not produced because buyers do not value it very highly.
II. not being consumed by buyers who value it most highly.
III. not being produced by the lowest-cost producers.
IV. being produced with less than all available resources.
IV only
II, III, and IV only
I and III only
I, II, III, and IV
III and IV only
II and III only
I and II only
I, II, and III only
II and III only
I is wrong is because it is NOT INEFFICIENCY
II is correct and inefficient cause we are organising demand and supply curve by arranging them from highest willingness to pay to lowest willingness to pay. Arrange sellers from lowest cost to highest cost
Which of the following statements is not valid when supply is perfectly elastic?
I. The elasticity of supply approaches infinity.
II. Very small changes in price lead to large changes in quantity supplied.
III. The time period under consideration is more likely to be a short period than a long period.
I and III only
I, II, and III
III only
I only
II and III only
Neither I, II, nor III
I and II only
II only
III only
I is correct cause PES = any/0 = infinity
When price elasticity of demand is greater than supply, who will benefit more?
sellers
