Micro Economics - Mid Term #2 Flashcards
Elasticity
A measure of responsiveness of quantity demanded or supplied to one of its determinants
Price Elasticity of Demand
A measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price
What influences the price elasticity of demand?
- Availability of Close Substitutes - Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others. Example - Butter and Margarine. Increase in the cost of butter causes the sales of butter to fall.
- Necessities vs Luxuries - Necessities tend to have inelastic demand, where as luxuries have elastic demands.
- Definition of Market - Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. Ex. Food = broad category. Ice cream = narrow category. Vanilla Ice Cream = very narrow category. Other flavours of ice cream are almost perfect substitutes.
- Time Horizon - Goods tend to have more elastic demand over longer time horizons. Example: Gasoline - when prices rise, quantity demand only falls slightly in first few month. Over time people buy fuel efficient cars, take the bus, move closer to work. Eventually quantity of gas demanded falls substantially.
How is the Price Elasticity of Demand Computed?
The percentage change in the quantity demanded divided by the percentage change in the price.
Price elasticity of demand = Percentage change in quantity demanded
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Percentage change in price
What is absolute value?
The common practice of dropping the minus sign and reporting all price elasticities of demand as positive numbers.
When is demand considered Elastic?
When the elasticity is greater than 1, which means the quantity moves proportionately more than the price.
When is Demand considered inelastic?
When the elasticity is is less than 1 which means the quantity moves proportionately less than the price.
When is the demand said to have unit elasticity?
If the elasticity is exactly 1, the percentage change in quantity equals the percentage change in price.
What does it mean if the demand is perfectly inelastic?
The demand curve is vertical.
Regardless of the price, the quantity demand stays the same.
Hint: Inelastic curves look like the letter I
What does it mean if the demand is perfectly elastic?
The price elasticity of demand approaches infinity and the demand curve becomes horizontal, reflecting the fact that very small changes in the price lead to huge changes in the quantity demanded.
Total Revenue (in a market)
The amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold
Income elasticity of demand
A measure of how much the quantity demanded of a good responds to a change in consumers’ income, computed as the percentage changed in quantity demanded divided by the percentage change in income
Cross-price elasticity of demand
A measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good devised by the percentage changed in the price of the second good
Price elasticity of supply
A measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price.
Supply of a good is said to be elastic if . . .
The quantity supplied responds substantially to changes in the price.
Example - Manufactured goods such as books, cars, television because firms that produce them can run factories longer in order to meet the demand.
Supply is said to be inelastic if . . .
The quantity supplied responds only slightly to the change in the price.
Example - Beach front land (impossible to produce more of it)
The price elasticity of supply depends on . . .
The flexibility of sellers to change the amount of the good they produce.
In most markets the key determinant of the price elasticity of supply is?
The time period being considered.
Over short periods of time firms cannot change the size of their factories to make more or less of a good. Thus in the short run, the quantity supplied is not very responsive to price. Over longer periods of time, firms can build new factories or close old ones. Additionally, new firms can enter a market and old firms can exit. Thus in the long run, the quantity supplied can respond substantially to price changes.
Economists compute the price elasticity of supply as . . .
The percentage change in the quantity supplied divided by the percentage change in the price.
Price elasticity of supply = Percentage change in quantity supplied
—————————————-
Percentage change in price
Example on page 102
Define the price elasticity of supply?
Get answer
Explain why the price elasticity of supply might be different in the long run than in the short run?
Get answer
Price Ceiling
A legal maximum price at which a good can be sold
Price Floor
A legal minimum on the price at which a good can be sold
How do you determine percentage change in price?
Take the delta from the two numbers
Divide by the initial price
Multiply by 100.
Example
Price of a bottle of wine . Initial Price $15. New Price $19. 19-15=4
4 divided by 15 = .27. Multiplied by 100 = 27%
What is the difference between Elasticity and Elasticity to Demand?
Elasticity - Measure of quantity demanded or quantity supplied
Elasticity to Demand - Investigates the sensitivity to demand and to price
Price elasticity of demand will always be a negative number.
Define the Law of Demand
When price increase, Quantity decreases
Because Price elasticity of demand is always a negative result . . .
You do not need to put a negative sign. It is implied.
All other elasticities require a minus sign.
For the final determination in elasticity of demand. Is it price divided by quantity or quantity divided by price?
Quantity divided by price
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What does it mean if something is an unrelated good?
Price elasticity will equal zero. One has no effect on the other.
Ex, a raise in the price of toothpick has no impact on cars.
Give an example of a price ceiling?
Rent Control
Give an example of a price floor
Minimum Wage
When is a price floor not binding?
When the Equilibrium price is above the price floor
When is a price floor Binding?
When the minimum price is above the equilibrium price
Define Tax Incidence
The manner in which the burden of a tax is shared among participants in a market
