Reading 14: Topics in Demand & Supply Analysis Flashcards
How do you calculate price, income, and cross-price elasticities of demand? What factors affect each measure?
1.) PRICE ELASTICITY OF DEMAND
a.) Calculate Price Elasticity
Price elasticity=
(change in quantity/quantity) divided by (change in price/price)
PED= change Q %/ change in P %
PED>1 Elastic PED=1 Unitary Elastic PED<1 Inelastic PED= INFINITY perfectly elastic PED=0 perfectly inelastic
EX: If consumers eat 10 honey crisp apples when price is $2 per apple and 14 honey crisp apples when the price is $1.80 per apple. What is price elasticity?
PED= CHANGE IN Q %/CHANGE IN P % PED= (14-10/10) / (2-1.80/2)= .4/.1= 4 REALLY ELASTIC
How do you calculate price, income, and cross-price elasticities of demand? What factors affect each measure?
2.) INCOME ELASTICITY OF DEMAND
Income Elasticity is equal to the CHANGE IN QUANTITY or CHANGE IN DEMAND for goods/services when you have an INCREASE IN INCOME.
IED= CHANGE IN Q%/CHANGE IN INCOME%
EX: If consumers buy 6 golf shirts every summer when their income is $50,000/year and 8 golf shirts when income is $55,000/year. What is the income elasticity?
IED= (8-6/6)/ (55000-50000/50000)= 3.3333
Income Elasticity is POSITIVE for NORMAL GOODS.
How do you calculate price, income, and cross-price elasticities of demand? What factors affect each measure?
3.) CROSS-PRICE ELASTICITY OF DEMAND
Cross-Price Elasticity of Demand- does the quantity purchased of one good affect the price of another good?
CPED= change in quantity %/ change in price %
EX: Consumers buy 10 cases of Coca Cola per day when price is $6.00/case and when the price of pepsi is $6.40/case, consumers buy 12 cases of coca-cola. What is the cross-price elasticity?
CPED= (12-10/10)/ (6.40-6.00/6.00) = .2/.06= 2.98 pretty elastic
CONCLUSION: Since, a change in slight price for one good causes the change in purpose of another good, we can conclude that since the 2 items reflect a CPED greater than 1, that they are SUBSTITUTE GOODS.
What is the difference between substitution effect (substitute goods) and income effects?
SUBSTITUTION EFFECT SAYS:
1.) CROSS-PRICE ELASTICITY OF DEMAND (GREATER THAN 1)
- ) If Price for substitute goes up , then quantity demand of other substitute will ALSO GO UP.
* WHY? Because the two items have CPED >1
INCOME EFFECT SAYS:
1.) INCREASE IN INCOME CAUSES INCREASE IN QUANTITY DEMANDED
So now we know the difference between substitute goods and how to determine if they are substitutes. Now, what is the difference between an inferior good and a normal good?
Normal Goods & Inferior Goods can be determined by looking at: INCOME ELASTICITY OF DEMAND!!!!
Normal Goods- we are looking at goods that are already being purchased on a regular basis. If income INCREASES-> purchase of more of those goods.
Inferior Good- is going to do the opposite; as a person’s income increases, they will purchase less of those goods!
IED= CHANGE IN QUANTITY DEMANDED %/ CHANGE IN INCOME DEMANDED%
Special: What is a Giffen Good?
Giffen Good is an inferior good. As income increases people will purchase more of this good.
EX: Rice, Bread, potato, etc.
Special: What is a Veblen Good?
Veblen Goods are normal goods so when income increases, demand also increases. HOWEVER, THEY ARE NOT SUBSTITUTE GOODS.
They have no substitutes in the market because they are considered collectibles.
So they are considered normal goods which increase with IED.
NOT SUBSTITUTE GOODS SO CPED is less than 1.
EX of Veblen Goods: Luxury goods, rolls royce, bentley, rolex, yacht
Describe the phenomenon of diminishing marginal returns.
Look at the Demand Curve:
- the marginal return for an extra marginal output decreases as marginal input increases.
Ex: You buy 1 candy bar and you are 10/10 happy, you buy 2 candy bars and that second candy bar is 6/10 happy.
Determine and describe breakeven points & shutdown points of production.
A.) Breakeven Point
Revenues= production costs
Revenues= FC + VC
B.) Shutdown Point (Breakeven Pt)
revenue= production costs (breakeven point is shutdown point)
Describe how economies of scale and diseconomies of scale affect costs.
A.) Economies of Scale- as a producer produces 1;10;1000;10,000 donuts, the price per marginal unit goes down
EX: 1st donut- $500
2nd donut- $.50
B.) Diseconomies of Scale- usually only applicable to conglomerates that have multiple costs to weigh out; the example that is given is the increase in the marginal cost per unit of product created to even out the total costs for other businesses.
