Elasticity

Question 1

What is the Law of Demand?

Answer 1

inverse relationship between price and quantity demanded

Question 2

Define price elasticity of demand

Answer 2

measure of price responsiveness

Question 3

When is a demand elastic?

Answer 3

when an increase in price
-> decreases the quantity demanded a lot

Question 4

When is a demand inelastic?

Answer 4

when an increase in price
-> decrease the quantity demanded a little

Question 5

Elasticity rule

Answer 5

elasticity isn’t equal to the slope
BUT
if two linear demand/supply curves run through a point FLATTER IS MORE ELASTIC

Question 6

Equation for price elasticity of demand

Answer 6

% change in quantity demanded/ %change in price

top= change in quantity demanded/ initial quantity demanded x100

bottom= change in price/ initial price x100

Question 7

Midpoint method

Answer 7

% 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

Question 8

Price elasticity

Answer 8

a good can have a price elasticity as low as zero or as high as infinity

Question 9

Interpreting the price elasticity of demand

Answer 9

<1 = inelastic
>1 = elastic
=1 = unit-elastic

Question 10

Extremely low elasticity of demand

Answer 10

perfectly inelastic demand has price elasticity of 0
no matter the change in price the demand will be the same

Question 11

Extremely high price elasticity of demand

Answer 11

perfectly elastic demand has price elasticity of demand = infinity

Question 12

Unit elasticity of demand

Answer 12

unit elastic demand has price elasticity of demand = 1

Question 13

Inelastic demand

Answer 13

price elasticity of demand = 0.5

Question 14

Elastic demand

Answer 14

price elasticity of demand=2

Question 15

Describe total revenue

Answer 15

TR= Price x quantity

• sellers need to know how elastic demand is so they can plan
• government want to know this information for tax policies

Question 16

Describe total revenue

Answer 16

TR= Price x quantity

• sellers need to know how elastic demand is so they can plan
• government want to know this information for tax policies

Question 17

Describe price effect and quantity effect

Answer 17

-when a seller raises the price of a good, there are two countervailing effects

Price effect- after a price increase, each unit sells at a higher price
-> tends to raise revenue

Quantity effect- after a price increase, fewer units are sold
-> tends to lower revenue

Question 18

What happens when demand is inelastic?

Answer 18

the price effect dominates the quantity effect
- so an INCREASE in price will cause only a slight reduction in the quantity demanded

-total revenue will rise when the price rises

Question 19

What happens when demand is elastic

Answer 19

the quantity effect dominates the price effect
- so an increase in price will cause significant reduction in the quantity demanded

• total revenue will fall

Question 20

What happens when demand is unit-elastic

Answer 20

the quantity effect equals the price effect

• so an increase in price exactly balances the reduction in the quantity demanded

-total revenue doesn’t change

Question 21

1) How do you know if a good is a necessity or a luxury?

Answer 21

for necessities: quantity demanded doesn’t change much in response to a change in price

for luxuries: quantity demanded is more sensitive to a change in price

Question 22

2) The availability of close substitutes

Answer 22

-fewer substitutes make it harder for consumers to adjust to Q when P changes
-> demand is inelastic

-many substitutes make it easier for consumers to switch brands when prices change
-> demand is elastic

Question 23

3) the share of income spent on the good

Answer 23

-feels cheaper when we spend a smaller share of income on the good

• feels more expensive when we spend a greater share of income on the good

Question 24

4) Time elapsed since the price change

Answer 24

-less time to adjust means lower elasticity
-over time consumers can adjust their behavior or find substitutes making demand more elastic