exam 3

Question 1

Price Elasticity of Demand (E_D)

Answer 1

a measure of the flexibility of quantity demanded to a change in the price (consumer price sensitivity).

Question 2

When consumers are very price sensitive

Answer 2

we say their response to a price change is ELASTIC.

Question 3

When consumers are not very price sensitive

Answer 3

we say their response to a price change is INELASTIC.

Question 4

Factors that Determine Price Elasticity of Demand

Answer 4

The availability of substitutes, Time Horizon, Nature of the Product, Share of Budget, Addiction

Question 5

The availability of substitutes

Answer 5

The availability of substitutes: As the # of available substitutes rises, demand becomes more elastic (and vice versa).

• For goods with many substitutes, switching brands when prices change is EASY, so demand is elastic
• For goods with fewer substitutes, consumers find it HARD to adjust quantity demanded much when prices change… so demand is inelastic

Question 6

Time Horizon

Answer 6

Time Horizon: The more time buyers have to adjust to a price change, the more elastic the demand for a good becomes.

• Immediately following a price increase, consumers may not be able to alter their consumption patterns (making demand inelastic)
• Over time, however, consumers can adjust their behavior by finding substitutes (making demand elastic)

Question 7

Nature of the Product

Answer 7

Nature of the Product: The more the good is a necessity (rather than a luxury), the more inelastic demand will be.

• For necessities, consumers do not change quantity demanded much when the price changes (making demand inelastic)
• For luxuries, consumers will alter their behavior when the price rises (making demand elastic)

Question 8

Share of Budget

Answer 8

Share of Budget: The greater the share of a consumer’s budget that is devoted to a good, the more elastic demand will be.

• Consumers are less concerned about price changes when the good feels cheap (making demand inelastic)
• Consumers become much more concerned about price changes when the good feels expensive (making demand elastic)

Question 9

Addiction

Answer 9

Addiction: If a product is habit-forming, the rise in its price would not induce much change in demand. Thus, the demand for habit-forming goods is less elastic.

• if a product is habit-forming the rise in its price would not induce much change demand (making demand inelastic)
• if a product is not habit-forming the rise in its price would induce much change demand (making demand elastic)

Question 10

The elasticity of Demand and Slope of the Demand Curve

Answer 10

○ Slope and elasticity are not the same things (two different numbers)
○ BUT Comparing relative slopes of two demand curves allows you to compare elasticity between them.

Question 11

perfectly inelastic demand

Answer 11

○ the demand is always going to stay the same, no matter what you charge for the good.

Question 12

perfectly elastic demand

Answer 12

basically, any demand that exists only exists at one price. And then if you charge any other price, you’re going to not sell any of the products.

Question 13

Price Discrimination

Answer 13

Definition: Charging different prices to different consumers for the same product.

Question 14

Three Necessary Conditions for Price Discrimination:

Answer 14

1. Consumers in the market must have heterogeneous (different) preferences for their products.
2. The demand curve for the good/service cannot be perfectly elastic.
3. The firm must prevent resale and arbitrage.

Question 15

Three Types of Price Discrimination

Answer 15

1.First-Degree (Perfect) Price Discrimination, 2.Second-Degree (Indirect) Price Discrimination, 3.Third-Degree (Segmenting) Price Discrimination

Question 16

First-Degree (Perfect) Price Discrimination

Answer 16

First-Degree (Perfect) Price Discrimination: The firm charges each consumer their exact willingness to pay for the good.

Question 17

Second-Degree (Indirect) Price Discrimination

Answer 17

Second-Degree (Indirect) Price Discrimination: The firm offers a menu of products that are designed such that consumers will self-select into the option that best fits their preferences for the good.

Question 18

Third-Degree (Segmenting) Price Discrimination

Answer 18

Third-Degree (Segmenting) Price Discrimination: A firm charges consumers a different price based upon some observable characteristic/trait.

Question 19

First-Degree (Perfect) Price Discrimination

When can firms utilize this pricing strategy?

Answer 19

– When firms have PERFECT information about EACH individual consumer’s maximum willingness to pay for the good/service
– Ex: “Free consultation” by lawyers, Car Dealerships?
Any other market where bargaining is a market norm

Question 20

Second-Degree (Indirect) Price Discrimination

When can firms utilize this pricing strategy?

Answer 20

– Firms must know what types of demand curves are present in the market for their good/service as well as the distribution of these types.
– Ex: Nonlinear pricing, “No cover before xPM” (a time), Cell Phones/Other technology.
“I GOTTA HAVE NEWEST AND NICEST PHONE THE DAY IT COMES OUT!!!!!!!!!” people

Question 21

Third-Degree (Segmenting) Price Discrimination

When can firms utilize this pricing strategy?

Answer 21

– When some observable characteristic is correlated with differential demand for the good/service in question.
– Ex: Student discounts at the movie theater, Senior citizen discounts, “Ladies Night” at clubs/bars.

Question 22

Price Elasticity of Supply (E_S)

Answer 22

a measure of the flexibility of quantity supplied to a change in the price (producer’s price sensitivity).

Question 23

When producers are very price sensitive

Answer 23

we say that their response to a change in prices is ELASTIC.

Question 24

When producers are not very price sensitive

Answer 24

we say that their response to a change in prices is INELASTIC.

Question 25

Cross-Price Elasticity of Demand (X_D)

Answer 25

Measures how much the quantity demanded of one product changes when the price of another product changes (a measure of how products are related).

Question 26

Three types of relationships between goods:

Answer 26

1. Substitutes: Butter/Margarine, Coke/Pepsi, Jam/Jelly, etc.
2. Complements: Milk/Cereal, Hot Dogs/Buns, PB&J, Shoes/Shoelaces, etc.
3. Unrelated: Gas/PB, etc.

Question 27

Three Necessary Conditions for Price Discrimination:

Consumers in the market must have heterogeneous (different) preferences for their products.

Answer 27

• If all consumers prefer the product the exact same, there is no incentive for firms to price discriminate.

if you didn’t have someone that was willing to pay a high price and someone else is willing to pay a low price. You couldn’t charge them different prices.

Question 28

Three Necessary Conditions for Price Discrimination:

The demand curve for the good/service cannot be perfectly elastic.

Answer 28

• If the demand curve is perfectly elastic then charging any other price is not possible.

Question 29

Three Necessary Conditions for Price Discrimination:

The firm must prevent resale and arbitrage.

Answer 29

• Arbitrage, in this context, is the practice of reselling a product at a price higher than its original price in a secondary market.
If this requirement is not met, consumers subject to lower prices could simply purchase the excess product and resell to those facing the higher price.

Question 30

Decriminalization

Answer 30

Decriminalization – the abolition of criminal penalties in relation to certain acts.

No longer addressed by criminal justice system.

• Still subject to penalties.

EX: If caught with small amounts of marijuana in places that have decriminalized, then will not gain a criminal record nor will be sent to jail. Still may be fined or have driver’s license revoked.

Question 31

Legalization

Answer 31

• Legalization – the abolition of all or most legal detriments from a previously illegal act.

No longer subject to penalties.
• Still subject to regulation.

• EX: If caught with small amounts of marijuana in places that have legalized, then will not gain a criminal record, will not be sent to jail, and will not be fined. Still may have to pay for a permit, taxes, and/or be subject to testing.

Question 32

Demand Side Interventions

Answer 32

Demand Side Interventions - Demand-side enforcement and strategy hold demand down.

ex: • “Just say no.” (Under first Bush administration) – Marketing and public health campaign.
• D.A.R.E. program – Drug Abuse Resistance Education
• Punishment for consumers caught using- fines, citations, prison time, Monitoring (ex. Underage alcohol use at UK football)