Equilibrium and Elasticities (Weeks 7-8) Flashcards
The benefit that consumers derive from consuming a good, above and beyond the price they paid for the good
Consumer surplus
What is the graphical representation of consumer surplus?
The area below the demand curve and above the price at the equilibrium point
What two factors determine consumer surplus?
- The market equilibrium point
- Elasticity of demand
Quantity demanded is not very sensitive to prices
Inelastic demand
Quantity demanded is very sensitive to prices
Elastic demand
What is the relative steepness of the demand curve with very elastic demand? Inelastic?
Inelastic demand: very steep demand curve
Elastic demand: very flat demand curve
True or false: as demand becomes more inelastic, consumer surplus rises
True
True or false: as demand becomes more elastic, consumer surplus rises
False; as demand becomes more elastic, consumer surplus falls because the demand curve becomes flatter
True or false: elastic demand arises from the availability of very good substitutes
True
True or false: inelastic demand arises from the availability of very good substitutes
False; arrises due to a lack of substitutes (not sensitive to price because people with pay any amount)
The benefit that producers derive from selling a good, above and beyond the cost of producing that good
Producer surplus
The percentage change in supply for each percentage change in market prices
Price elasticity of supply
The percentage change in quantity demanded for each percentage change in prices
Elasticity of demand
What is the equation for price elasticity of demand
(percentage change in quantity demanded) / (percentage change in price)
(Change in Q/Q) / (Change in P/P)
What is the equation for price elasticity of supply
(Percentage change in quantity supplied) / (Percentage change in price)
(Change in Q/Q) / (Change in P/P)
What are the two conditions for market equilibrium?
Marginal cost (MC) = Marginal benefit (MB)
Quantity demanded = Quantity supplied
When the market price has reached the level where quantity supplied equals quantity demanded
Equilibrium, also called competitive equilibrium
Price at which both sellers and buyers are satisfied
Equilibrium price, also called market-clearing price
True or false: the equilibrium changes only if a shock occurs that shifts the demand curve or supply curve
True
True or false: shocks have the same effect independent of the shape of the supply or demand curve
False; a shock has different effects depending on the shape of the demand or supply curve
This is because the shape of the curve is dependent on elasticity of demand or supply
A summary statistic that describes how much the quantity demanded changes in response to an increase in price at a given point
Price elasticity of demand
Percentage change in one variable in response to a given percentage change in another variable
Elasticity
What are each of the parts of the equation for a linear demand curve?
Q = a - bp
Q: elasticity of demand
a: quantity demanded when price is 0
-b: ratio of the fall in quantity to the rise in price
p: price
What is the elasticity of demand for a linear demand curve:
Q = a - bp
-b (p/Q)
Rearranged and substituted from the price elasticity of demand formula
The point where the elasticity of demand is 0
Perfectly inelastic
The point where the elasticity of demand is approaching infinity
Perfectly elastic
A point where a 1% increase in price causes a 1% decrease in quantity
Unitary elastic
Where on a demand curve graph is demand perfectly elastic?
Where the demand curve intersects the price axis (y intercept)
Where on a demand curve graph is demand perfectly inelastic?
Where the demand curve intersects the quantity demanded axis (x intercept)
What are the two extreme cases of perfectly elastic demand curves?
Vertical demand curves and horizontal demand curves
In what situations is a demand curve horizontal?
When consumers view this good as identical to another good–the demand curve is horizontal at the price of the other good
In what situations is a demand curve vertical?
For essential goods–consumers will pay any price to get a good
What is the formula for revenue?
Price x quantity purchased
What is the formula for income elasticity of demand?
percentage change in quantity demanded
_____________________________________________
percentage change in income
Change in Q/Q
_______________
Change in Y/Y
What is the formula for the cross-price elasticity of demand?
percentage change in quantity demanded
_____________________________________________
percentage change in price of another good
Change in Q/Q
_______________
Change in Po/Po
A measure of how sensitive the quantity demanded at a given price is to changes in income
Income elasticity of demand
A measure of how sensitive the quantity demanded at a given price is to changes in the price of another good
Cross-price elasticity of demand
If the cross-price elasticity is negative, are goods complements or substitutes?
Complements
This means people buy less of the good when the price of the other good increases (demand curve shifts left)
If the cross-price elasticity is negative, are goods complements or substitutes?
Substitutes
This means people buy more of the good when the price of the other good increases (demand curve shifts right)
How are the demand and supply curves affected for the ice cream market if there is an abnormally hot summer?
How does this affect price and quantity demanded?
Supply is expected to increase due to firms’ expectations of increased sales (shift right because external force)
Demand is expected to increase due to a change in preferences/shock (shift right because external force)
Quantity demanded will increase, but price change is dependent on the magnitude of the shifts–could increase, decrease, or stay the same
How are the demand and supply curves affected for the ice cream market if there is an increase in the price of sugar?
How does this affect price and quantity demanded?
Supply is expected to decrease due to an increase in the price of inputs (shift left because external force)
Demand is expected to move along the supply curve to match the supply shift (shift along the demand curve)
The cost of sugar does not affect consumers directly, so there is no shift in the demand curve
Interpret a price elasticity of demand of -2
For every 1% increase in price, the quantity demanded will decrease by 2%
Interpret a price elasticity of supply of 3
For every 1% increase in price, the quantity supplied will increase by 3%
True or false: price elasticities of demand are always negative
True
True or false: price elasticities of supply are always negative
False; they are positive with an upward sloping supply curve
They are negative with a downward sloping supply curve (uncommon)
What is the elasticity of supply for a linear supply curve:
Q = g + hp
h (p/q)
Is supply generally more elastic or inelastic when comparing short term and long term?
Long term is usually more elastic, as the firm has more time to adjust
What type of sales tax is this: for every dollar the consumer spends, the government keeps a fraction
Ad valorem tax
What people traditionally think of as sales tax
What type of sales tax is this: a specified dollar amount is collected per unit of output
Specific or unit tax
Is this is an ad valorem tax or unit tax?
The US government collects 18.4 cents of tax on every gallon of gas sold in the US
Specific or unit tax
Is this an ad valorem or unit tax?
The state of Kentucky collects 6% of the total cost of your shopping bill
Ad valorem tax
How does a specific collected on producers affect the supply curve?
Shifts it left and decreases total supply
How does a specific collected on consumers affect the demand curve?
Shifts it left and decreases total demand
Does the equilibrium price and quantity depend on whether the specific tax is collected from suppliers or consumers?
No; the equilibrium point is the same
The amount of revenue collected is also the same
How does a specific tax affect the price customers pay, the equilibrium quantity, and total tax revenue?
Price paid increases
Equilibrium quantity decreases
Total tax revenue increases
What determines the amount of a tax on producers that is passed onto consumers?
Elasticities of supply and demand
The share of the tax that falls on consumers
OR
The amount by which the price to consumers rises as a fraction of the amount the tax increases
Incidence of a tax on consumers
What is the formula for the incidence of the tax that falls on consumers?
supply elasticity
_______________________________________
(supply elasticity - demand elasticity)
True or false: for a given supply elasticity, the more elastic demand is, the less the eq price rises when a tax is imposed
True
True or false: for a given demand elasticity, the greater the supply elasticity, the smaller the increase in eq price customers pay when a tax is imposed
False; for a given demand elasticity, the greater the supply elasticity, the larger the increase in eq price
How does an ad valorem tax collected on consumers affect the demand curve?
Rotates the demand curve inwards (towards the x axis), decreasing the slope of the demand curve
How does an ad valorem tax collected on consumers affect the supply curve?
Does not affect the supply curve
Another word for a negative tax where firms are given money by the government to incentivize a behavior
Subsidy
How does a subsidy affect eq price and quantity?
Lowers eq price and increases eq quantity
How does a subsidy affect the supply curve?
Shifts it to the right, increasing supply
The sum of consumer and producer surplus
Total welfare
Where is the total cost to the consumer located graphically on a demand curve?
Rectangular area multiplying the eq price and quantity
Where is the total benefit to the consumer located graphically on a demand curve?
Total cost + net benefit (consumer surplus)
Aggregation of all marginal benefits (willingness to pay)
Area under the demand curve to the left of the eq quantity
Where is the net benefit (consumer surplus) located graphically on a demand curve?
Area under the demand curve until the eq price
Where is the total cost to the producer located graphically on a supply curve?
Area under the supply curve until the eq quantity demanded
Where is the net benefit (producer surplus) located geographically on a supply curve?
Area above the supply curve until the eq price
Where is the total benefit to the producer located geographically on a supply curve?
Rectangular area multiplying the eq price and quantity
How is the total benefit for producers related to the total price paid by consumers?
They are the same in an equilibrium and perfectly competitive market
Is demand more elastic or inelastic for a demand curve with a very flat slope?
More elastic
What are examples of goods that are usually elastic?
Goods with lots of substitutes, such as luxury items
Luxury cars, sodas, cereals
Is demand more elastic or inelastic for a demand curve with a very steep slope?
More inelastic
What are examples of goods that are usually inelastic?
Goods with very few substitutes, essential items
Food, gas, electric, heat
Is consumer surplus higher or lower with elastic vs inelastic demand curves?
Consumer surplus is highest with inelastic goods
This is because your willingness to pay (marginal benefit) is relatively much higher for a good that you value because you need it
A measure of the responsiveness of one variable to a change in one of its determinants
Elasticity
Is demand elastic or inelastic when the absolute value of elasticity is greater than 1
Elastic
This means small changes in price lead to large changes in quantity
Is demand elastic or inelastic when the absolute value of elasticity is less than 1
Inelastic
This means small changes in price lead to small changes in quantity
Is elasticity constant as we move along a linear demand curve
No; the slope is constant but the starting point on the curve is different, creating different elasticities
What are the two things that determine elasticity?
- Slope
- Ratio of the starting point on the curve
If two demand curves with different slopes pass through the same point, will they have the same elasticity at that point?
No because elasticity is determined by the slope and starting point. Even if they have the same starting point, the slopes are different, so they have different elasticities
What two conditions will cause consumer surplus to decrease?
- Price increase
- Demand curve becomes more elastic (horizontal)
What two conditions will cause producer surplus to decrease?
- Price decrease
- Supply curve becomes more inelastic (vertical)
The reduction in welfare from a loss of surplus by one group that is not offset by a gain to another group from an action that alters market equilibrium
Deadweight loss
What two factors determine deadweight loss size?
- Price elasticity of demand
- Price elasticity of supply
