Exam 2 Flashcards
What is price elasticity of demand?
The price elasticity of demand measures how much the quantity demanded responds to a change in price.
price elasticity
- Linear demand curves
Lower half of curve is inelastic (E<1), upper half is elastic (E>1), midpoint is unitary elastic (E=1)
midpoint formula for measuring elasticity between two points on the curve
(Q2-Q1) / [(Q2+Q1) / 2]
/ (p2-p1) / [(p2+p1) / 2]
point formula for measuring elasticity at a point on the curve
= %ΔQ / %ΔP
=(ΔQ / Q) / (ΔP / P)
= (ΔQ / ΔP) * (P / Q)
= (P / Q) * (1 / slope)
Determinants of price elasticity of demand
- Price elasticity of demand is determined by the number of substitutes for the product that are available.
- 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
Define Income elasticity of demand
Measures how the quantity demanded changes as consumer income changes.
Income elasticity of demand
- If E>0, the good is a normal good
a. If E>1, the good is a “luxury good”
b. If 0
Income elasticity of demand
- If E<0
the good is an inferior good
Measuring income elasticity of demand
Same formulas as for price elasticity of demand, but replace P with I (income)
Cross-price elasticity of demand
- Definition
Measures how the quantity demanded of one good responds to a change in the price of another good.
Cross-price elasticity of demand
- If E>0
the two goods are substitutes in consumption
Cross-price elasticity of demand
- If E<0
the two goods are complements in consumption
Measuring cross-price elasticity of demand
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)
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
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.
Price elasticity of supply
- Definition
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.
Linear supply curves, upward-sloping
- Linear supply curves that intersect the price axis have :
E>1
Linear supply curves, upward-sloping
- As price and quantity increase:
E becomes closer to 1
Linear supply curves that intersect the quantity axis have:
E>1
Linear supply curves that intersect the quantity axis:
- As price and quantity increase:
E becomes closer to 1
Linear supply curves that intersect the origin have:
E=1
Vertical supply curves have:
E=0
Horizontal supply curves have:
E=infinity (undefined)
Determinants of price elasticity of supply:
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
Three questions to be answered about economic policies and social goals
- Does the policy achieve the goal, and if so, at what cost to society?
- If the policy does not achieve the goal, are there other policies that do?
- Among the policies that achieve the goal, which does so at the lowest cost?
The economic effects of price floors (e.g., minimum wage laws)
- The impact on buyers, sellers, and on society
- Is there a better alternative to a price floor?
a. subsidy
b. effect of the subsidy
c. cost to society
The economic effects of price ceilings (e.g., rent control)
- The impact on buyers, sellers, and on society
- Is there a better alternative to a price ceiling?
a. subsidy
b. effect of the subsidy
c. cost to society
