Exam 2

Question 1

What is price elasticity of demand?

Answer 1

The price elasticity of demand measures how much the quantity demanded responds to a change in price.

Question 2

price elasticity

- Linear demand curves

Answer 2

Lower half of curve is inelastic (E<1), upper half is elastic (E>1), midpoint is unitary elastic (E=1)

Question 3

midpoint formula for measuring elasticity between two points on the curve

Answer 3

(Q2-Q1) / [(Q2+Q1) / 2]

/ (p2-p1) / [(p2+p1) / 2]

Question 4

point formula for measuring elasticity at a point on the curve

Answer 4

= %ΔQ / %ΔP
=(ΔQ / Q) / (ΔP / P)
= (ΔQ / ΔP) * (P / Q)
= (P / Q) * (1 / slope)

Question 5

Determinants of price elasticity of demand

Answer 5

1. Price elasticity of demand is determined by the number of substitutes for the product that are available.
2. Other factors that affect E, like the length of time over which demand is measured, affect E because they are related to the number of substitutes available
   a. Example: Demand is more elastic over longer time periods because one can find or create more substitutes the longer is the time period over which demand is measured

Question 6

Define Income elasticity of demand

Answer 6

Measures how the quantity demanded changes as consumer income changes.

Question 7

Income elasticity of demand

- If E>0, the good is a normal good

Answer 7

a. If E>1, the good is a “luxury good”

b. If 0

Question 8

Income elasticity of demand

- If E<0

Answer 8

the good is an inferior good

Question 9

Measuring income elasticity of demand

Answer 9

Same formulas as for price elasticity of demand, but replace P with I (income)

Question 10

Cross-price elasticity of demand

- Definition

Answer 10

Measures how the quantity demanded of one good responds to a change in the price of another good.

Question 11

Cross-price elasticity of demand

- If E>0

Answer 11

the two goods are substitutes in consumption

Question 12

Cross-price elasticity of demand

- If E<0

Answer 12

the two goods are complements in consumption

Question 13

Measuring cross-price elasticity of demand

Answer 13

Same formulas as for price elasticity of demand, but replace Q with QX (quantity of good X, and replace P with PY (price of good Y)

Question 14

Using price, income, and cross-price elasticities of demand to estimate future demand for a product
- If you know the size and sign of the elasticities

Answer 14

you know what will happen to the price of your product, and you have information of what is likely to happen to consumer income or the price of a substitute or complementary good, you can calculate the impact on expected demand for your product.

Question 15

Price elasticity of supply

- Definition

Answer 15

measures how much the quantity supplied responds to changes in the price. Supply of a good is said to be elastic if the quantity supplied responds substantially to changes in the price. Supply is said to be inelastic if the quantity supplied responds only slightly to changes in the price.

Question 16

Linear supply curves, upward-sloping

- Linear supply curves that intersect the price axis have :

Answer 16

E>1

Question 17

Linear supply curves, upward-sloping

- As price and quantity increase:

Answer 17

E becomes closer to 1

Question 18

Linear supply curves that intersect the quantity axis have:

Answer 18

E>1

Question 19

Linear supply curves that intersect the quantity axis:

- As price and quantity increase:

Answer 19

E becomes closer to 1

Question 20

Linear supply curves that intersect the origin have:

Answer 20

E=1

Question 21

Vertical supply curves have:

Answer 21

E=0

Question 22

Horizontal supply curves have:

Answer 22

E=infinity (undefined)

Question 23

Determinants of price elasticity of supply:

Answer 23

The longer the time period over which supply is measured, the greater the price elasticity of demand, other things equal

a. market-period supply curves are vertical and E=0 because no inputs can be changed in such a short period—they are all “fixed” for that period
b. short-run supply curves are upward-sloping and E>0 because there is at least one variable input and at least one fixed input
c. long-run supply curves can be horizontal and E=infinity because all inputs can be varied in the long run—no fixed input

Question 24

Three questions to be answered about economic policies and social goals

Answer 24

1. Does the policy achieve the goal, and if so, at what cost to society?
2. If the policy does not achieve the goal, are there other policies that do?
3. Among the policies that achieve the goal, which does so at the lowest cost?

Question 25

The economic effects of price floors (e.g., minimum wage laws)

Answer 25

1. The impact on buyers, sellers, and on society
2. Is there a better alternative to a price floor?
   a. subsidy
   b. effect of the subsidy
   c. cost to society

Question 26

The economic effects of price ceilings (e.g., rent control)

Answer 26

1. The impact on buyers, sellers, and on society
2. Is there a better alternative to a price ceiling?
   a. subsidy
   b. effect of the subsidy
   c. cost to society