Elasticity

Question 1

price elasticity of demand

Answer 1

the ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve (dropping the minus sign).

The larger the price elasticity of demand, the more responsive the quantity demanded is to the price. When the price elasticity of demand is large— when consumers change their quantity demanded by a large percentage compared with the percent change in the price—economists say that demand is highly elastic.

Question 2

Demand is perfectly inelastic when

GRAPH

Answer 2

the quantity demanded does not respond at all to changes in the price. When demand is perfectly inelastic, the demand curve is a vertical line.When the price elasticity of demand is less than 1, they say that demand is inelastic.

Question 3

Demand is perfectly elastic when

GRAPH

Answer 3

any price increase will cause the quantity demanded to drop to zero. When demand is perfectly elastic, the demand curve is a horizontal line. When the price elasticity of demand is greater than 1, economists say that demand is elastic

Question 4

unit elastic demand

Answer 4

an economic theory that assumes a change in price will cause an equal proportional change in quantity demanded.

Question 5

total revenue

Answer 5

the total value of sales of a good or service. It is equal to the price multiplied by the quantity sold.

Question 6

price effect

Answer 6

After a price increase, each unit sold sells at a higher price, which tends to raise revenue.

Question 7

A quantity effect

Answer 7

After a price increase, fewer units are sold, which tends to lower revenue.

Question 8

unit elastic demand and revenue

Answer 8

If demand for a good is unit-elastic (the price elasticity of demand is 1), an increase in price does not change total revenue. In this case, the quantity effect and the price effect exactly offset each other. When demand is unit - elastic, the two effects exactly balance; so a fall in price has no effect on total revenue.

Question 9

elastic demand and revenue

Answer 9

If demand for a good is elastic (the price elasticity of demand is greater than 1), an increase in price reduces total revenue. In this case, the quantity effect is stronger than the price effect. When demand is elastic, the quantity effect dominates the price effect; so a fall in price increases total revenue.

Question 10

inelastic demand and revenue

Answer 10

If demand for a good is inelastic (the price elasticity of demand is less than 1), a higher price increases total revenue. In this case, the price effect is stronger than the quantity effect. When demand is inelastic, the price effect dominates the quantity effect; so a fall in price reduces total revenue.

Question 11

What Factors Determine the Price Elasticity of Demand? (4)

Answer 11

1) the availability of close substitutes - The price elasticity of demand tends to be high if there are other readily available goods that consumers regard as similar and would be willing to consume instead. The price elasticity of demand tends to be low if there are no close substitutes or they are very difficult to obtain.
2) whether the good is a necessity or a luxury - The price elasticity of demand tends to be low if a good is something you must have, like a life - saving medicine. The price elasticity of demand tends to be high if the good is a luxury—something you can easily live withou
3) the share of income a consumer spends on the good - The price elasticity of demand tends to be low when spending on a good accounts for a small share of a consumer’s income. In that case, a significant change in the price of the good has little impact on how much the consumer spends. In contrast, when a good accounts for a significant share of a consumer’s spending, the consumer is likely to be very responsive to a change in price. In this case, the price elasticity of demand is high.
4) how much time has elapsed since the price change - In general, the price elasticity of demand tends to increase as consumers have more time to adjust to a price change. This means that the long - run price elasticity of demand is often higher than the shortrun elasticity.

Question 12

cross - price elasticity of demand

Answer 12

between two goods measures the effect of the change in one good’s price on the quantity demanded of the other good. It is equal to the percent change in the quantity demanded of one good divided by the percent change in the other good’s price.

Question 13

When two goods are substitutes (cross-price elasticity of demand)

Answer 13

like hot dogs and hamburgers, the cross - price elasticity of demand is positive: a rise in the price of hot dogs increases the demand for hamburgers—that is, it causes a rightward shift of the demand curve for hamburgers. If the goods are close substitutes, the cross - price elasticity will be positive and large; if they are not close substitutes, the cross - price elasticity will be positive and small. So when the cross - price elasticity of demand is positive, its size is a measure of how closely substitutable the two goods are.

Question 14

when two goods are complements (cross-price elasticity of demand)

Answer 14

like hot dogs and hot dog buns, the cross - price elasticity is negative: a rise in the price of hot dogs decreases the demand for hot dog buns—that is, it causes a leftward shift of the demand curve for hot dog buns. As with substitutes, the size of the cross - price elasticity of demand between two complements tells us how strongly complementary they are: if the cross - price elasticity is only slightly below zero, they are weak complements; if it is very negative, they are strong complements.

Question 15

income elasticity of demand

Answer 15

the percent change in the quantity of a good demanded when a consumer’s income changes divided by the percent change in the consumer’s income.

Question 16

price elasticity of supply

Answer 16

a measure of the responsiveness of the quantity of a good supplied to the price of that good. It is the ratio of the percent change in the quantity supplied to the percent change in the price as we move along the supply curve. The price elasticity of supply is the percent change in the quantity supplied divided by the percent change in the price.

Question 17

There is perfectly inelastic supply

Answer 17

when the price elasticity of supply is zero, so that changes in the price of the good have no effect on the quantity supplied. A perfectly inelastic supply curve is a vertical line.

Question 18

There is perfectly elastic supply

Answer 18

when even a tiny increase or reduction in the price will lead to very large changes in the quantity supplied, so that the price elasticity of supply is infinite. A perfectly elastic supply curve is a horizontal line.

Question 19

What Factors Determine the Price Elasticity of Supply?

Answer 19

The Availability of Inputs - The price elasticity of supply tends to be large when inputs are readily available and can be shifted into and out of production at a relatively low cost. It tends to be small when inputs are difficult to obtain—and can be shifted into and out of production only at a relatively high cost.

Time The price elasticity of supply tends to grow larger as producers have more time to respond to a price change. This means that the long - run price elasticity of supply is often higher than the short - run elasticity. (In the case of the flu vaccine shortfall, time was the crucial element because flu vaccine must be grown in cultures over many months.)

Question 20

minimiza efficiency costs of taxation

Answer 20

The implication of this result is clear: if you want to minimize the efficiency costs of taxation, you should choose to tax only those goods for which demand or supply, or both, is relatively inelastic. For such goods, a tax has little effect on behavior because behavior is relatively unresponsive to changes in the price. In the extreme case in which demand is perfectly inelastic (a vertical demand curve), the quantity demanded is unchanged by the imposition of the tax. As a result, the tax imposes no deadweight loss. Similarly, if supply is perfectly inelastic (a vertical supply curve), the quantity supplied is unchanged by the tax and there is also no deadweight loss. So if the goal in choosing whom to tax is to minimize deadweight loss, then taxes should be imposed on goods and services that have the most inelastic response—that is, goods and services for which consumers or producers will change their behavior the least in response to the tax. (Unless they have a tendency to revolt, of course.) And this lesson carries a flip-side: using a tax to purposely decrease the amount of a harmful activity, such as underage drinking, will have the most impact when that activity is elastically demanded or supplied.

Question 21

The tax incidence depends on

Answer 21

the relative price elasticity of supply and demand. When supply is more elastic than demand, buyers bear most of the tax burden. When demand is more elastic than supply, producers bear most of the cost of the tax. Tax revenue is larger the more inelastic the demand and supply are.

Question 22

The tax revenue generated by a tax depends on

Answer 22

the
tax rate and on the number of units transacted with the tax. Excise taxes cause inefficiency in the form of deadweight loss because they discourage some mutually beneficial transactions. Taxes also impose
administrative costs: resources used to collect the
tax, to pay it (over and above the amount of the tax),
and to evade it

Question 23

An excise tax

Answer 23

generates revenue for the government but lowers the total surplus. The loss in total surplus exceeds the tax revenue, resulting in a deadweight loss to society. This deadweight loss is represented by
a triangle, the area of which equals the value of the
transactions discouraged by the tax. The greater the elasticity of demand or supply, or both, the larger the deadweight loss from a tax. If either demand or supply
is perfectly inelastic, there is no deadweight loss from
a tax.