Elasticity, Microeconomic Policy, and Consumer Theory Flashcards
elasticity
the measure of the sensitivity of a thing (such as demand or supply) to change in an external factor
price elasticity of demand
the sensitivity of consumer demand for a given good when the price of that good changes
price elasticity of demand formula
E~d = (%change in Q~d) / (%change in price)
price elastic demand
when E~d > 1, aka when % change in Q~d is greater than % change in P
price inelastic demand
when E~d < 1, aka when % change in Q~d is less than % change in P
unit elastic demand
when E~d = 1, aka when the % change in Q~d is equal to % change in P
perfectly inelastic
when E~d = 0; in this case, the demand curve is vertical and there is absolutely no change in the quantity demand, regardless of the price
perfectly elastic
when E~d = infinity; in this case, the demand curve is horizontal and there is an infinitely large change in the amount of demand as price increases
slope and elasticity
in general, the more vertical a good’s demand curve, the more inelastic the demand for that good; the more horizontal a good’s demand curve, the more elastic the demand for that good; despite this generalization, elasticity and slope are still not equivalent measures
determinants of elasticity
if a good has more readily available substitutes (luxuries vs. necessities), it is likely that consumers are more price elastic for that good; if a high proportion of a consumer’s income is devoted to a particular good, consumers are generally more price elastic for that good; over larger periods of time, consumer response is oftentimes more elastic
total revenue
TR = P * Q~d
total revenue test
total revenue generally rises with a price increase if demand is price inelastic and falls with a price increase if demand is price elastic
elasticity and demand curves
at the midpoint of a linear demand curve, E~d =1; above the midpoint demand is elastic and below the midpoint demand is inelastic
income elasticity
a measure of how sensitive consumption of a given good is to a change in the consumer’s income
income elasticity formula
E~i = (%change in Q~d) / (% change in income)
luxury
a good for which income elasticity is greater than 1
necessity
a good for which the income elasticity is above zero, but less than one
values of income elasticity of demand
if E~i > 1, the good is normal and a luxury; if 1 > E~i > 0, the good is normal and income inelastic; if E~i < 0, the good is inferior
cross-price elasticity of demand
a measure of how sensitive consumption of a given good is in response to a change in the price of another good
cross-price elasticity formula
E~xy = (% change in Q~D good X) / (% change in price of good Y)
values of cross-price elasticity of demand
if E~xy > 0, goods X and Y are substitutes; if E~xy < 0, goods X and Y are complementary
price elasticity of supply
the measure of the sensitivity of a quantity supplied of a given good when the price of that good changes
price elasticity of supply formula
E~s = (% change in Q~S) / (% change in P)
excise tax
a per unit tax on production that results in a vertical shift in the supply curve by the amount of the tax
incidence of tax
the proportion of the tax paid by consumers in the form of a higher price for the taxed good is greater if demand for the good is inelastic and supply is elastic
dead weight loss
the lost net benefit to society caused by a movement away from the competitive market equilibrium as a result of outside intervention; policies like excise taxes create lost welfare to society
subsidy
how the opposite effect of an excise tax, as it lowers the marginal cost of production, resulting in a downward vertical shift in the supply curve a given good
price floor
a legal minimum price below which the product cannot be sold; if a floor is installed at some level above the equilibrium price, it creates a permanent surplus
price ceiling
a legal maximum price above which the product cannot be sold; if a ceiling is installed at some level below the equilibrium price, is creates a permanent shortage (not necessarily manifested in decreased number of units, could be manifested in decreased value of units)
utility
happiness, benefit, satisfaction, or enjoyment gained from consumption
total utility
total happiness received from the consumption of a number of units of a good
marginal utility
the incremental happiness received from consumption of a number of units of a good
utils
a unit of measurement often used to quantity utility; it has no set value
Law of Diminishing Marginal Utility
in a given time period, the marginal (additional) utility from consumption of more and more of that item falls
constrained utility maximization
constrained by price and income, a consumer stops consuming a good when the price paid for the next unit is equal to the marginal benefit received
utility maximizing rule
the consumer maximizes utility when they choose amounts of goods with their limited income so that the marginal utility per dollar spent is equal for all goods; for example, for goods X and Y:
MU~X / P~X = MU~Y / P~Y
or
MU~X / MU~Y = P~X / P~Y
horizontal summation
the process of adding, at each price, the individual quantities demanded to find the market demand curve for a good
