Intro - Chptr 6/Elasticities

Question 1

“Elasticity” refers to _____________ .

Answer 1

Responsiveness.

Question 2

What is price elasticity of demand?

Answer 2

The percentage change in quantity demanded divided by the percentage change in price:
E (demand) = % Δ in quantity demanded / % Δ in price

Question 3

What is price elasticity of supply?

Answer 3

Percentage change in quantity supplied divided by the percentage change in price:
E (supply) = % Δ in quantity supplied / % Δ in price.

Question 4

Demand or supply is “elastic” if:

Answer 4

E > 1
% Δ in quantity (supplied or demanded) is > % Δ in price.
An elastic supply/demand means that quantity changes by a larger % than the % change in price.

Question 5

Demand or supply is “inelastic” if:

Answer 5

E < 1
% Δ in quantity (supplied or demanded) is < % Δ in price.
An inelastic supply/demand means that the quantity doesn’t change much with a change in price.

Question 6

What is the end-point problem and how is this problem solved?

Answer 6

% Δ in price or quantity differs depending on whether you view the change as a rise or decline. Easiest way to solve this problem is to use the average of the two end values to calculate % Δ:
|E| = Q2 - Q1/0.5(Q1+Q2) / P2 - P1/0.5(P1+P2).

Question 7

Perfectly elastic?

Answer 7

E = infinity. Quantity responds enormously to changes in price.
IMAGES: perfectly elastic supply & demand curves.

Question 8

Perfectly inelastic?

Answer 8

E = 0. Quantity does not change at all to changes in price.

IMAGES: graphs of perfectly inelastic supply and demand curves.

Question 9

Unit elastic?

Answer 9

E = 1. Percent change in quantity equals percent change in price.
IMAGES: supply & demand graphs of unit elastic.

Question 10

How is elasticity determined along linear demand curves?

Answer 10

(1) Determine x & y intercepts; (2) midway between the origin and x-axis intercept, draw line up to demand curve- that point is unit elastic; (3) elasticity declines along demand curve as near the x-axis.
IMAGE: ELASTICITY ALONG THE DEMAND CURVE.

Question 11

How is elasticity determined along linear supply curves?

Answer 11

(1) IF the lower endpoint of the supply curve intersects with the y-axis, then E is infinity at the y-intercept and elasticity declines as travel up the supply curve.
(2) IF the lower endpoint of the supply curve intersects with the x-axis, then E is 0 at the x-intercept and elasticity increases as travel up the supply curve.
(3) IF the lower endpoint of the supply curve intersects at the origin, then the E at the origin is 1 and the supply curve has unit elasticity. IMAGE: ELASTICITY IN SUPPLY CURVES.

Question 12

What is the most important determinant of price elasticity of demand? What are the most important 4 factors which affect this determinant?

Answer 12

Determinant: Substitution. Substitution is most affected by (1) time period being considered - longer the interval, the more elastic the demand curve as there are more substitutes in the long-run; (2) degree to which a good is a luxury - the less a good is a necessity, the more elastic its demand curve; (3) market definition- as the definition becomes more specific, demand becomes more elastic; (4) importance of the good in one’s budget- demand for goods that represent a large proportion of one’s budget is more elastic than demand for goods that represent a small proportion of one’s budget.

Question 13

What is the most important determinant of elasticity of supply? What is the most important factor in this determinant and how does this factor impact elasticity of supply?

Answer 13

Determinant is substitution. The factor that has the most affect on substitution when considering elasticity of supply is the time period being considered: (1) in the instantaneous period, quantity supplied is fixed so supply is perfectly inelastic; (2) in the short run, some substitution is possible, so short-run supply curve is somewhat elastic; (3) in the long run, significant substitution is possible so the supply curve becomes very elastic.
*Additional factor that affects substitution is the ease with which production of goods can be increased.

Question 14

What is total revenue (TR)?

Answer 14

Price x Quantity Sold = TR

Question 15

How does elasticity of demand affect TR?

Answer 15

E(d) > 1 (elastic): ⬆P ⬇TR
E(d) = 1 (unit elastic): ⬆P ⬅➡TR (TR is unchanged)
E(d) < 1 (inelastic): ⬆P ⬆TR

Question 16

What is price discrimination?

Answer 16

When firms charge a higher price to people with less elastic demand and a lower price to people with more of an elastic demand.

Question 17

What is income elasticity of demand? Does it represent a shift in the demand curve or movement along the demand curve?

Answer 17

Income elasticity of demand = % Δ in demand / % Δ in income.
It shows the responsiveness of demand to changes in income and represents a SHIFT since it represents a response in demand to something other than price.

Question 18

What are normal goods and what is their income elasticity?

Answer 18

Normal goods are goods whose consumption increase with an increase in income; they have income elasticities > 0. Normal goods are divided into luxuries and necessities.

Question 19

What is a luxury good?

Answer 19

A normal good that has income elasticity > 1; % increase in demand is > than % increase in income.

Question 20

What are necessities?

Answer 20

A normal good whose income elasticity of demand is < 1; % increase in demand is less than % increase in income.

Question 21

What are inferior goods?

Answer 21

Goods whose consumption decreases when income rises; they have a negative income elasticity.

Question 22

Cross-Price Elasticity of Demand

Answer 22

% Δ in demand / % Δ in price of a related good. This is a demand curve SHIFT.

Question 23

Substitutes

Answer 23

Goods that can be used in place of one another. Substitutes have positive cross-price elasticities of demand- as price of one good increases, demand of its substitutes increases.

Question 24

Complements

Answer 24

Goods that are used in conjunction with other goods; complements have negative cross-price elasticities of demand- fall in the price of a good will increase demand of its complement.

Question 25

The concept of elasticity is useful to supply and demand analysis because:

Answer 25

It helps us determine to what extent there will be a change in equilibrium quantity and equilibrium price, given a change in demand & supply.

Question 26

What is the formula for % Δ in price when demand shifts using elasticities of supply/demand?

Answer 26

% Δ in price = % Δ in demand / E(demand) + E(supply)

Question 27

What is the formula for % Δ in price when supply shifts using elasticities of supply/demand?

Answer 27

% Δ in price = % Δ in supply / E(demand) + E(supply)

Question 28

How will an inelastic supply shift effect inelastic demand?

Answer 28

Effect on Δ in price will be greater than effect on Δ in quantity. In general effects of supply shifts on equil. price/quantity are determined by E(demand).
IMAGE: INELASTIC SUPPLY & INELASTIC DEMAND.

Question 29

How will inelastic supply shift effect elastic demand?

Answer 29

Effect on Δ in price will be less than effect on Δ in quantity. In general effects of supply shifts on equil. price/quantity are determined by E(demand).
IMAGE: INELASTIC SUPPLY & ELASTIC DEMAND.

Question 30

How will a demand shift effect elastic supply?

Answer 30

The more elastic the supply, the greater the effect of a demand shift on quantity and the smaller the effect on price.