exam 2 Flashcards
price elasticity of demand
measure how responsive buyers are to price change
what % △ QD in response to 1% price △
PED equation
%△ QD
———-
%△ P
ex:
uber cut price by 15%
QD for uber rose by 30%
|30%|
——- = |-2| = 2
|-15%|
- ratio 2:1
for every 1% increase in P
QD decrease by 2%
elastic
QD is responsive to △P
- P increase = large △ in QD
inelastic
QD is not responsive to △P
- P increase = little △ in QD
unit elastic
% △ P will cause an equal % △ QD
- PED = 1
-ex:
↑ price 10% means △ QD will also be 10%
elastic demand curve
PED > 1
%△QD > %△P
- flat curve
perfectly elastic demand
PED = ∞
%△QD is ∞ for any %△P
- horizontal curve
inelastic demand curve
PED < 1
%△QD < %△P
- steep curve
perfectly inelastic demand curve
PED = 0
%△QD is 0 for any %△P
- vertical curve
Demand Elasticity Factor 1
- more competing products = greater elasticity
- more substitute = more elastic demand will become (more choices)
Demand Elasticity Factor 2
- specific brand vs. broad category of good
- specific brand have more elastic demand
- ex:
1. P of cheerios increase (specific brand) - people will substitute different cereals making it elastic
2. P of breakfast cereals increase (category of breakfast) - demand is inelastic since they would have to find an alternative breakfast
Demand Elasticity Factor 3
- necessities have inelastic demand
- things that you can’t go without, you will keep buying even if price increase
Demand Elasticity Factor 4
- consumer research = elastic demand
- consumers are willing to search for a low cost alternative making demand more elastic
Demand Elasticity Factor 5
- demand get more elastic over time
midpoint formula
measure % △ between 2 point
% △ QD or QS equation
Q2 - Q1
—————— x 100
(Q2 + Q1) / 2
% △ P equation
P2 - P1
—————— x 100
(P2 + P1) / 2
% △ QD if nothing is given
PED x % △ P
total revenue
price x quantity
- elastic demand: higher prices lead to less revenue
-inelastic demand: higher price lead to more revenue
Revenue - Elastic demand
price ↑ = revenue ↓
price ↓ = revenue ↑
Revenue - demand inelastic
price ↑ = revenue ↑
price ↓ = revenue ↓
cross - PED
% △ P of another good
- positive for substitute
(buy more good when price of another good ↑ ) - negative for complement
(good A price ↑ = good B QD ↓ )
cross - PED positive for substitute example
coke = $2
pepsi = $3
pepsi $ ↑ = buy more coke
cross - PED negative for complement example
cereal price ↑ 10%
QD for milk ↓ 6%
- 6 %
——- = -0.6
10 %
( -6 let us know its a complement)
income elasticity of demand (IED)
measure how responsive demand for a good is when income change
IED equation
% △ income
normal good
income ↑ normal good QD ↑
positive IED
inferior good
income ↑ inferior good QD ↓
negative IED
easy memorization
PED = price of this good (apple n apple
Cross - PED = price of another good
(apple n banana)
IED = price of income
(apple n paycheck)
Price elasticity of supply
measure how responsive sellers are to price change
PES
% △ P
perfectly inelastic supply
PES = 0
% △ QS = 0 for any % △ P
- vertical curve
inelastic supply
PES < 1
% △ QS < % △ P
- steep curve
perfectly elastic supply
PES = ∞
% △ QS is ∞ for any % △ P
- flat curve
elastic supply
PES > 1
% △ QS > % △ P
- flat curve
Supply Elasticity Factor 1
- inventories make supply more elastic
- inventories provide flexibility to respond quickly to price change
Supply Elasticity Factor 2
- easily available variable inputs make supply elastic
- input needed to expand production are easily available = elastic supply
Supply Elasticity Factor 3
- extra capacity = elastic supply
- if a business have capacity, they can produce more output w out raising cost
Supply Elasticity Factor 4
- easy entry n exist = elastic supply
- business able to easily enter or exit a market when price change
Supply Elasticity Factor 5
- supply is elastic over time
excise tax
Tax per unit
- tax already included in the price
sale tax
addition tax to the price
(increase total price)
tax on seller
shift supply curve
tax = marginal cost to seller
-additional cost to each unit
MC ↑ (tax added) = left shift to supply curve
tax affect on seller n buyers
- ↓ quantity sold
- ↑ price buyers pay
- ↓ seller profit
- seller n buyers bear economic burden
statutory burden
burden of being assigned by the government to send a check of tax collected on behalf of the gov
economic burden
burden faced by buyers and sellers due to tax changing total prices
tax incidence
division of tax economic burden between sellers n buyers
tax on buyers
tax on good ↓ MB - shifting demand curve left
buyer bear larger share of tax incidence
- demand is inelastic
- supply is elastic
buyer bear smaller share of tax incidence
- demand is relatively elastic
- supply is relatively inelastic
Evaluating taxes step 1
determine which curve shifts
Evaluating taxes step 2
increase or decrease in tax?
increase = left shift
decrease = right shift
Evaluating taxes step 3
compare pre-tax w post-tax equilibrium
- change in equilibrium price and quantity
Evaluating taxes step 4
is supply or demand relatively elastic
equation to determine who bear greater economic burden
tax = buyer price - seller price
buyer economic burden = buyer price - old price
seller economic burden = old price - seller price
PED > PES = buyer bear larger
PED < PES = buyer bear less
subsidy
money granted by government to assist business
- subsidy for consumers = ↑ QD
- subsidy for sellers = ↑ QS
price ceiling
max price sellers can legally charge (they cant charge a higher price)
- shortage
- goal: lower price
“you can only sell at __ price.”
price ceiling negative
- shortage never solved
- lack of innovation
- loss of incentive
- increase bias (should i sell it to that person)
price floor
Seller must charge above this minimum price
- surplus
- goal: increase price
“you can only sell above __ price”
binding price ceiling
when set below equilibrium
non-binding price ceiling
when set above equilibrium
binding price floor
when set above equilibrium
non-binding price floor
when set below equilibrium
quantity regulation
max or min quantity that can be sold
mandate
min quantity a good must be brought or sold
“must supply at least __ quantity”
quotas
limit max quantity a good that can be brought or sold
“you can only supply __ quantity”
binding mandate
when set to the right of equilibrium
binding quotas
set to the left of equilibrium
mandate & quota
vs.
price floor & ceiling
mandate & quota effect quantity
price floor & ceiling effects price
positive analysis
Describe what is happening, why, and what will happen
normative analysis
describes what should happen
economic efficiency
more generated economic surplus = better outcome
economic surplus
total benefits - total costs
efficient outcomes
MB = MC (provide largest possible economic surplus)
equity
measure fairness
consumer surplus
buyer gain of economic surplus from buying something
- gain when MB > price
consumer surplus equation
MB - Price
Area of triangle
1/2 x base x height
producer surplus
Sellers gain economic surplus from selling something
- gain when selling price > MC
producer surplus equations
Price - MC
voluntary exchange
buyers n sellers want to exchange money for goods
- both enjoy gains from the trade
economic surplus equation
MB - MC
(consumer surplus + producer surplus)
3 central question
- who makes what?
- who gets what?
- how much gets brought n sold
efficient production
(who makes what)
occur when producing a level of output at the lowest possible cost
- require sellers to produce good at lowest MC
efficient allocation
(who gets what)
occur when good are allocated to create largest economic surplus from allocations
- requires each good to go towards the person that gains the most MB
efficient quantity
(how much gets sold n brought)
quantity that are brought and sold to produce the largest possible economic surplus
Rational Rule for Market
increase economic surplus by producing more items as long as MB > MC
market failure
occur when the forces of supply n demand lead to inefficient outcome
Market Failure Source 1
- market power undermines competitive pressures
(When a business has too much control, it weakened the competitive pressures of the market)
- when there’s limited competition, sellers has too much control over price. They take advantage and manipulate price and lower quality goods without fear of losing to other business
Market Failure Source 2
- externalities create side effects
- when buyers and seller choices have side effects on other who are not involved
Market Failure Source 3
- information problem undermines trust
Private information can lead to lack of trust, leading people to buy or sell less than efficient quantity
-private information examples: sellers know more information about a product, and you feel like they’re hiding something so it leads to you not buying the product
Market Failure Source 4
irrational leads to bad decisions
Market Failure Source 5
gov impede market forces
- government intervention can interfere with the flow of the market
deadweight loss
measures economic surplus lost due to market failure
deadweight loss equations
efficient quantity - actual quantity
government failure
gov policies lead to worse outcome
- gov interventions = inefficient
gain from trades
benefits from reallocating goods to its better use
absolute advantage
ability to do a task efficiently using less effort than others
comparative advantage
ability to do tasks at a lower opportunity cost
opportunity cost of tasks equation
hrs to finish task /
hrs to finish alternative task
Role 1 of price
(power of price)
- price is a message
- price is a message to sellers
tells sellers how much buyers value their products - price is a message to buyers
tells buyers the MC of sellers (how much it cost to produce goods)
= help coordinate better outcomes
Role 2 of price
(power of price)
- price is an incentive
- price is incentive for suppliers
high price = incentive to increase productions - price is incentive for suppliers
high price = incentive to buy less
= provide incentive for stranger to cooperate
Role 3 of price
(power of price)
- price is a bundle of information
- the process of buying n selling collects information
- market price broadcast useful information
prediction markets
market designs so prices can be interpreted as probabilities and use to make predictions
internal markets
market within a company to buy n sell scarce resources
knowledge problems
knowledge needs to make a good decision but not available to decision maker
- market can solve knowledge problems
