Econ:Elasticity and Conumer Choice Flashcards
Elasticity
highly Elastic
very responsive (sensitive)
Elasticity
- Measure of responsiveness
- Degree of sensitivity
- Measures how change in one variable affects another variable
Elasticity
low elastice
not quite responsive (not very sensitive) ; inelastice
Price Elasticity of Demand (Ep)
- the responsiveness of Qd of a commodity to the changes in its Price
- how a consumer responds to a price change
Elastic Demand
Very responsive (sensitive)
Inelastic Demand
Not very responsive (sensitive)
Elasticity is: (4)
- unit free measurement
- always analyzed in absolute terms
- Ep > 1 Elastic Demand
Ep < 1 Inelastic Demand - calculate using midpoint formula
Ep > 1
% change Qd > % change P
Elastic
Relatively flat; more horizontal, the flatter the demand, the more elastic the demand
Ep < 1
% change Qd < % change P Inelastic The steeper (vertical) the demand, the more inelastic the demand
Extreme Cases of Price Elasticity of Demand (3)
- perfectly elastic demand
- perfectly elastic demand
- unit elastic demand
Perfectly Inelastic Ep
buyer does not respond to any price change
Ep=0
buyer will always purchase a fixed quantity
Demand curve is vertical
Perfectly Elastic Demand Ep
Infinite elasticity Ep= infinity extremely sensitive to price changes any price below P : buyer purchases extremely large Q any price above P : buyer purchases 0 Q Demand curve is horizontal
Unit Elastic Demand Ep
% change Qd = % change P
Ep=1
fixed budget
total revenue remains constant
Determinate’s of Ep (4)
- The availability of substitute goods
- The percent of the budget the good takes
- Passage of Time
- The nature of the good
Determinate of Ep : The availability of substitute goods
- more available substitute–> more Elastic Demand
a lot of types of substitutes - less available substitute–> more Inelastic Demand
not a lot of types of substitutes
Determinate of Ep : The percent of the budget that good takes
- greater %budget good takes–> more Elastic Demand
2. less %budget good takes–> more Inelastic Demand
Determinate of Ep : Passage of Time
- more time buyer has to adjust to P change–> more Elastic Demand
- less time buyer has to adjust to P change–> more Inelastic Demand
Determinate of Ep : The nature of the good
- luxury good–> Elastic Demand
2. Necessity good–> Inelastic Demand
Elasticity of Demand Ep and Total Revenue Test
Firm tries to predict how a price change effects the total revenue
TR = P x Q
TR = price per unit x number of units
Rules for the Total Revenue Test (3)
- Elastic Demand
- Unit Elastic Demand
- Inelastic Demand
Rules for Revenue Test : Elastic Demand
Ep > 1
inverse relationship
change P decreases change in TR increases
Rules for the Total Revenue Test : Unit Elastic
Ep=1
change P increases; TR– no effect
change P decreases; TR– no effect
Rules for Total Revenue Test : Inelastic Demand
Ep < 1
direct relationship
change P increases ; change TR increase
change P decreases ; change TR decreases
Ep looks at?
movement along a stationery demand curve.
Cross Price Elasticity (CO)
measures responsiveness of the buyers to change in P of related goods
Exy
x ; how quantity of x is related to price of y
y ; price of related goods
Exy > 0
(+) substitute
larger the # is (+) the more indicates its a substitute
Exy < 0
(-) compliment
the larger the # is (-) the more it indicates its a compliment good
Income Elasticity of Demand
Ei= % change Qd / % change Income
Ei > 0
(+) normal good
2 types of normal goods
Ei > 0 and Ei > 1
normal, luxury good
income elastic
buyer sensitive to change in income
Ei < 0
(-) inferior good
Ei > 0 and Ei < 1
(+) normal good ; necessity
income inelastic
buyer not quite sensitive to change in Income
Ei = 0
unrelated good
Demand Summary
3 measures of responsiveness
- price elasticity of demand (Ep)
- cross price elasticity (Exy)
- income elasticity (Ei)
Supply Elasticity
how responsive supply/producer is to a given change in price.
Es > 1
elastic supply
% change Qs > % change P
supply curve is flat
Es < 1
Inelastic supply
% change Qs < % change P
supply curve is more steep/vertical
Extreme Elasticities of Supply (3)
- perfectly inelastic supply
- perfectly elastic supply
- unit/unitary elastic supply
Extreme Elasticity: perfectly inelastic supply
Es=0
perfectly vertical supply curve
change P increase/decrease; Qs–> no effect
no sensitivity to change in P
Extreme Elasticity of Supply: perfectly elastic supply
Es= infinite extremely sensitive to any P change increase in P - extremely large Qs decrease in P - 0 Qs perfectly horizontal supply curve
Extreme Elasticity of Supply: Unit/Unitary Elastic
Es=1
% change Qs = % change P
45 degree angle to supply curve
Determinate’s of Es
definition
factors that cause a supplier to be elastic or inelastic to a given price change.
Determinate’s of Es (2)
- Time to adjust to P change
2. Availability of inputs used in production
Determinate of Es : Time to adjust to change in P
- more time to adjust to change P more elastic supply; long-run
- less time to adjust to change P more inelastic supply: short-run
determinate of Es : availability of inputs used in production
substituting one good for another
- more substitute inputs - more elastic supply
- less substitute inputs - more inelastic supply
Consumer Choice
model of consumer decision making
Utility Theory
one theory of consumer choice
Utility Theory : Assumption
Goal of consumer is to maximize utility
Utility definition (3 things)
- subjective measure of consumer satisfaction
- enjoyment, satisfaction, and pleasure a consumer receives from consuming; purchasing good/service
- no 2 people have the same utility
Util definition (3)
- 1 unit of utility
- subjective measure of utility
- hypothetical
Total Utility (TU)
the cumulative satisfaction from consuming all units of a good.
Marginal Utility (MU)
the extra/additional satisfaction from consuming one additional unit of a good
Utility Schedule (2 things)
- subjective measure of satisfaction
- depends on taste/preference for good.
Economic Decisions are made at the Margin
(+) MU increasing
TU increasing at a fast rate
(+) MU decreasing
TU still increasing
MU=0
TU increasing at slow rate; maximized in theory
- as more of good is consumed, eventually each additional unit is less and less satisfying
- area of diminishing return
- CAUTION: signal to buyer; you are approaching utility maximization.
MU=0 and TU
TU Maximized = Consumer Choice
MU = -1
(-) MU ; TU decreases
a rational consumer will NEVER consume the good.
Summary of marginal Analysis (5)
- as you consume more of a good generally TU increases.
Q increases TU increases - as long as MU increases TU increases
- as you consume more of a good MU eventually declines approaching consumer choice. increase Q decrease MU
- when MU=0 TU is maximized ; consumer choice
- when MU (-) TU decreases; rational consumer will NOT consider.
Consumer Optimization (CO)
- maximizes utility given the consumer’s limited income.
- they have a budget
- choice set of goods/service that maximizes consumer utility given the consumer’s income and prices of each good.
CO rules for 2 good case (2)
- equate MU/P= MU per dollar for each good.
2. always select additional units of a good that has the highest MU/P until all income is spent; zero income
2 effects on Consumer Optimum
- substitution effect of a P change
2. income effect of a P change
2 effects on CO : substitution effect a price change
a change in P that causes the consumer to substitute cheaper goods for relatively more expensive goods
effect on CO : income effect of a P change
a change in P that effects the purchasing power of the buyer’s money/income
Inflation ruins purchasing power
Price (5)
- an objective measure of buyer’s preference of a good
- measures the value for additional units of a good consumed
- measures additional utility from consuming additional units of a good.
- better indicator of consumer performance than MU because P is objective
- best indicator of value
MU
- a subjective measure of buyers preference for additional units of a good.
- closest measure in real world that you can get for MU is P
MU=P
Q increases P decreases MU decreases
Q decreases P increases MU increases
Consumer Surplus (CS)
a measure of Total Utility (TU)
Consumer SP (2 things)
- The area below the demand curve above the price.
2. The difference between what a consumer is willing to pay and what they actually pay
Consumer Surplus: The difference between what a consumer is willing to pay and what they actually pay.
- Water
Large TU > MU small : large supply; small demand - Diamonds
Small TU < MU large : small supply; large demand