Exam 2 (CH 4 and 5 and 6) Flashcards
Consumer Surplus
the difference between what consumers would be willing to pay and the market price
Consumer’s willingness to pay
is the max price at which he or she would buy that good
Consumer surplus is the are beneath the ______ and the area above the _______
demand curve; price
Consumer surplus ________ with a fall in price
rises
Producer surplus
the difference between the market price and the lowest price at which sellers are willing to supply the product (which is = cost of product)
Producer surplus is the are beneath the ______ and the area above the _______
price; supply curve
If the price increases, the producer surplus ______
rises
Total surplus
the sum of the producer and consumer surpluses
Price controls
legal restrictions on how high or low a market price may go
Price ceiling
a max price sellers are allowed to charge (usually set below the equilibrium)
Price floor
a minimum price buyers are required to pay (usually set above equilibrium)
If a price ceiling is set above equilibrium…
then it will have no effect (called nonbinding)
Binding or effective price ceiling
a price ceiling that forces price below equilibrium and has an effect
Deadweight loss
the loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the market equilibrium quantity
Deadweight loss is measured in
dollars
Who wins and loses in rent control example?
Producers lose; some lucky renters gain; some unlucky but willing renters don’t get a place at all
If a price floor is set below the equilibrium …
then it will have no effect (nonbinding)
Binding or effective price floor
a price floor that forces price above equilibrium will have an effect
price floors encourage
- Waste
- Black markets
Why are there price ceilings and floors?
- benefit some people (who are more vocal than those harmed)
- they’ve been around so long that people are used to them
- Gov officials don’t understand economics
Price elasticity of demand
measures how responsive consumers are to changes in price
If the demand curve is elastic
an increase in price reduces the quantity demanded a lot (and vice versa)
If the demand curve is inelastic
same increase in price reduces QD by just a little
Elasticity rule
- Elasticity does not equal slope
- If 2 linear demand (or supply) curves run through a common pain, then at any given Q, the curve that is flatter is more elastic
Price Elasticity of demand Equation
(% change in QD) / (% change in P)
If the price of oil increases by 10% and the QD decreases by 5% then what is the price elasticity of demand for oil?
(-5%) / (10%) = -0.5 (we usually drop the negative)
Midpoint method for calculating % changes
% change in x = (change in x) / (average value of x) * 100
Calculate average value of x
(starting value of x + Final value of x) / 2
Cross-price elasticity of demand definition
measures how sensitive the quantity demanded of good A is to the price of good B
Cross-price elasticity of demand for substitutes
cross-price elasticity of demand is positive
Ex: increase in price of 1 brand of cookie will increase the demand for the other brands
Cross-price elasticity of demand for compliments
Cross-price elasticity of demand is negative
Ex: increase in the price of milk causes a decrease in the demand for Oreos
When does cross-price elasticity of demand = 0?
when the products are not related
Income elasticity of demand definition
measures how sensitive the quantity demanded of a good is to changes in income
Income elasticity of demand for normal goods
Income elasticity of demand is positive
Income elasticity of demand for inferior goods
Income elasticity of demand is negative
Price elasticity of Supply definition
how sensitive producers are to changes in price of product
If the supply curve is: elastic
a rise in price increases the quantity supplied a lot (and vice versa)
If the supply curve is: inelastic
a rise in price increases the quantity supplied just a little (and vice versa)
|elasticity| < 1
demand curve is inelastic
|elasticity| > 1
demand curve is elastic
|elasticity| = 0
demand curve is unit elastic
Perfectly Inelastic Demand def
price elasticity of demand = 0; consumers are not at all sensitive to changes in price
Perfectly Inelastic Demand (what does it look like on a graph?)
vertical line – any increase in price doesn’t change QD
Perfectly elastic Demand def
price elasticity of demand = infinity; consumers are ultra sensitive to any change in price
Perfectly elastic Demand (what does it look like on a graph?)
horizontal line – at exactly one price all customers are willing to buy any quantity
What factors determine the price elasticity of demand?
- Availability of close substitutes
- if there are a lot of substitutes = elastic
- the fewer substitutes the more inelastic demand is - Whether the good is a necessity or a luxury
- Necessity: less sensitive to changes in P (inelastic)
- Luxury: more sensitive to changes in P (elastic) - Share of income spent on the good
- Price changes when good feels cheap (inelastic)
- Price changes when good feels expensive (elastic) - Length of time elapsed since the price changed
- Less time to adjust (inelastic)
- More time to adjust = ability to adjust behavior and find close substitutes (elastic)
Total Revenue equation
Price times quantity
When demand is inelastic, what happens to total revenue?
total revenue will rise when the price rises (and vice versa)
When demand is elastic, what happens to total revenue?
total revenue will fall when price rises
When demand is unit elastic, what happens to total revenue?
total revenue does not change
