Midterm 2 Flashcards
Price elasticity of demand
A measure of how much the quantity demanded of a good responds to change in price.
- demand is elastic is it responds substantially
- it’s not elastic if it only responds slightly.
= %change in Qd/% change in price
Determinants of elasticity
- Availability of close substitutes (more elastic)
- Necessities (in elastic) vs. Luxuries (elastic)
- Definition of the market (narrow-more elastic. Broad-less elastic)
- Time horizon (longer time horizon- more elastic)
Midpoint method
(Q2-Q1)/[(Q2-Q1/2] over (P2-P1)/[(P2+P1)/2
Elastic
Greater than one
Unit elasticity
If elasticity is exactly 1
Flatter the demand curve
Greater the price elasticity
Steeper the demand curve
Smaller the elasticity
Perfect in elastic
Demand curve is vertical and equals 0
Perfect elastic
Demand curve is horizontal and equals infinity
Total revenue
The amount paid by buyers and received by sellers of a good, computer as the price of the good times the quantity sold
PxQ
How Inelastic demand effects total revenue
Raises price, raises total revenue
How elastic demand affects total revenue
Raises price, lowers total revenue
Income elasticity of demand
A measure of how much the quantity demanded of a good responds to a change in consumers income
= % change in Qd / % change in income
Normal and inferior goods (income elasticity of demand)
Normal goods = positive
Inferior goods = negative
Luxury goods = large
Cross price elasticity demand
A measure of how much the Qd of one good responds to a change in price of another good
= % change in Qd of good 1 / % change in price of good 2
Positive or negative cross price elasticity
Positive if the two goods are substitutes
Negative if the two goods are complements
Price elasticity of supply
A measure of how much the quantity supplied of a good responds to the change in the price of that good
% Change in Qs/% change in price
Determinants of price elasticity of supply
The time period being considered (more elastic in the long run)
Price ceiling
A legal maximum on the price at which a good can be sold
Ex: rent control
Price floor
A legal minimum on the price at which a good can be sold
Ex: miminum wage
Not binding ceiling
If equilibrium is below ceiling, it has no effect on the price or quantity sold
Binding ceiling
If equilibrium is above ceiling, it can never reach ceiling, so the market price must equal the ceiling and a shortage will result
Not binding price floor
Equilibrium is above the floor, so it has no effect
Binding price floor
Equilibrium is below the floor so market price can never get there. Causes a surplus.
If minimum wage is above the equilibrium level
Labor supplied > labor demanded = unemployment
Tax incidence
The manner in which the burden of a tax is shared among participants in a market
Where does the tax burden fall more heavily?
On the side of the market that is less elastic
Welfare economics
The study of how the allocation of resources affects economic well being
Willingness to pay
The maximum amount that a buyer will pay for a good
Consumer surplus
The amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it
- the area below the demand curve and above the price
Marginal buyer
The buyer who would leave the market first if the price were any higher
- demand curve shows the willingness to pay of the marginal buyer
Cost
The value of everything a seller must give up to produce a good
Producer surplus
The amount a seller is paid for a good minus the sellers cost of providing it
Marginal seller
The seller who would leave the market first if the price were any higher
Total surplus
The sum of consumer and producer surplus
Value to buyers - cost to sellers
Efficiency
The property of a resource allocation of maximizing the total surplus received by all members of society
Equality
The property of distributing economic prosperity uniformly among the members of society
Result of tax on buyers
Decreases demand
Result of tax on suppliers
Increases supply
Total tax revenue
T x Q
Deadweight loss
The fall in total surplus that results from a market distortion, such as a tax
Determinants of deadweight loss
The price elasticities of supply and demand
- larger when more elastic
How to calculate deadweight loss
.
World price
The price of a good that prevails in the world market for that good.
- used to determine whether a country will import or export
Under free trade, domestic price equals
World price
When a country becomes An exporter of a good
Domestic producers are better off and domestic consumers are worse off
How does trade raise the economic well being of a nation
Gains of winners exceed the losses of the losers
When a country becomes an importer of a good
Domestic consumers are better off and domestic producers are worse off
Tariff
A tax on imported goods
What does a tariff do
Reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade
How to determine the total welfare effects of a tariff
Add change in consumer surplus (negative) to the change in producer surplus and change in government revenue
Benefits of international trade
Increased variety of goods
Lower cost through economies of scale
Increased competition
Enhanced flow of ideas
Arguments against trade
The jobs argument National security argument Infant-industry argument Unfair competition Protection as a bargaining chip
Externality
The uncompensated impact of one persons actions on the well being of a bystander
Negative externality
When the effect on a bystander is bad
Positive externality
When the effect of the bystander is beneficial or good
Negative externality graph
Social cost curve
Private value curve
Positive externality graph
Social value curve
Private value curve
Command and control policy or regulation
Remedies an externality by legally limiting a specific behavior
Trade able permit system
Remedies an externality by giving out permits to pollute and allowing firms to trade amongst themselves
Corrective subsidy
Subsidize firms with emissions reducing technology
Corrective tax
A tax equal to the negative external cost
- preferred over regulation
- efficient kind of taxes
Internalizing the externality
Altering incentives so that people take account of the external effects of their actions
Coase theorem
The proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own.
Why do private solutions not always work?
Transaction costs
Transaction costs
The cost that parties incur in the process of agreeing to and following through on a bargain
Elasticity
A measure of responsiveness of quantity demanded or quantity supplied to change in one of its determinants
