Test 2 - Market Efficiency and Elasticity Flashcards
What is Elasticity of Demand?
Elasticity of demand refers to the responsiveness of the change in quantity demanded in relation to (change in) price. Demand Curve
What is elastic demand?
Elastic demand occurs when the change in a product’s quantity demanded is proportionally greater than a change in price. It is usually represented by a “flatter” demand curve.
What is inelastic demand?
Inelastic demand occurs when the change in a product’s quantity demanded is proportionally less than a change in price. It is usually represented by a “taller” supply curve with an I shape.
Determinants of Price Elasticity of Demand (PED)
- The availability of substitutes
- Whether it is a luxury or necessity
- Time (In the short term, products are more inelastic; over time more elastic because more substitutes are found.
- Proportion of Income spent (a good that was a lower proportion of income tends to be inelastic).
What is Perfect Inelastic demand?
If a change in price results in no change to quantity demanded, the Coefficient = 0 (perfectly inelastic)
What is Perfect Elastic demand?
If a change in price results in infinitely large change in quantity demanded, the ED = ∞ (perfectly elastic)
What is Unitary Elasticity of demand?
When the coefficient is 1, it is called Unitary Elasticity. Price change is proportional to Quantity demanded change.
What coefficient range is relatively inelastic in demand?
Less than 1
What coefficient range is relatively elastic in demand?
More than 1
How to calculate PED?
percent change in quantity / percent change in price
Change in Quantity x Original Price / Original Quantity x Change in Price
How is the Mid-Point method different to point method of demand?
The mid-point method is very similar to the point methods. The only difference is, instead of using the original price, we use the average price. Instead of using the original quantity, we use the average quantity.
What is Total Revenue (TR), Formula
Total Revenue refers to the total amount of income business or firms gain from selling a good or service. TR = P x QD
Does a Business want to sell more demand elastic or demand inelastic goods? How does this affect Total Revenue?
A business wants to sell more inelastic goods. This means that consumers will not react as much to an increase in price. This will increase revenue and profit.
What is Price Elasticity of Supply?
The responsiveness of the quantity supplied of a good or service by producers to a change in the good or service’s prices. Supply of curve
What can producers do if supply of a product is inelastic; elastic?
If supply is inelastic, producers will struggle to change production in a given time. If supply is elastic, producers can increase output without a rise in cost or a time delay.
If price is elastic >1, what is the effect on suppliers and what is an example of a supply elastic good?
Sellers are sensitive to a price change, Manufactured goods.
If price is inelastic <1, what is the effect on suppliers and what is an example of a supply inelastic good?
Sellers are not sensitive to a price change, Agricultural goods.
Unitary Supply Elasticity?
Unitary Supply of Elasticity is 1. Price and Quantity supplied change is exactly the same proportion.
Perfect Supply Inelastic and what is an example of a perfectly supply inelastic good.
A change in price has no effect on quantity supplied. Rare, valuable 1:1 goods.
Determinants of Price Elasticity of Supply
- Ability to store inventory
- Nature of industry
- Time
Time Determinant
If the producer can respond quickly to a price change, then supply will be price elastic. If inventories are low, this may be hard to do. As time increases the supply of goods tend to become more elastic due to an increase in the factors of production
Nature of Industry Determinant
The supply of agricultural products is quite inelastic, while the supply of manufactured goods is usually more elastic. Agricultural products take a long time to produce, they cannot respond quickly to price changes. Manufactured goods on the other hand are relatively easy to produce and can make changes to production faster.
Ability to store inventory determinant.
Inventories refer to stocks that a producer keeps stored for future sales. If a producer has the ability to store its goods, then it can respond fairly quickly to a change in demand (price) and so supply would be elastic.
Price Discrimination and how can businesses use this tactic?
Different consumer groups have different price elasticity of demand for the same products. Businesses can use this information to charge different prices and increase their total revenue.
Price discrimination definition
Price discrimination is a practice when businesses charge different prices for different demographics, situations, or times for the same product depending on their elasticity to price changes.
GST
10% Australia
Excise taxes
Extra taxes on other good such as petrol, alcohol and Tobacco. Inelastic goods.
Tax Effect on Producer and effect on supply?
A tax is a cost to the producer highest cost. It is shown by a decrease and shift leftwards of supply. The amount of the tax is the size of the supply shift.
Tax implementation: Price change, Tax Amount, New Quantity (change size), What do producers receive after, Government tax revenue amount.
Original Price P1, new price with tax amount P2
Vertical distance between two supply curves is tax amount (P2 - P3)
New quantity is at Q2 (leftwards shift), Not much due to being inelastic.
Producers receive P3, should’ve been P1 without tax.
Government tax revenue can be calculated by (P2-P3) x (Q2) - L*W of the tax amount box to find area of rectangle.
How does Inelastic or Elastic Tax graph Supply Curve?
Demand Curve shape changes.
What is Market Efficiency?
Market Efficiency is producing goods and services that the society wants at the lowest possible cost.
Efficient market impact on societal wellbeing. Inefficient market impact on societal wellbeing.
In an efficient market, it is not possible to make someone better off without making someone else worse off. Conversely, when an outcome is inefficient, it is possible to improve total well-being in society by reallocating resources.
What does a demand curve represent?
A demand curve is a willingness to pay curve. It reflects the maximum price that a consumer will pay for a good.
What is a consumer surplus definition
It is the difference between what a consumer is prepared to pay and what they actually pay in the market.
Consumer Surplus area
Consumer Surplus is the area above the original price but below the demand curve.
What does Consumer surplus measure?
Measure of economic wellbeing for consumers. Consumers are better off because they pay less and consumer more.
What does the Supply Curve represent?
The supply curve represents the minimum price that producers are willing to sell their products (cost of production - price willing to accept)
Producer surplus definition
Producer surplus is the difference between what a producer is willing to receive and what they actually receive.
Producer Surplus area
It is the area that is below the price, and above the supply curve.
What does producer surplus measure?
- An increase in producer surplus means that the producer is better off – there economic welfare has increased.
- Producers are better off because they receive more and can supply more.
Total Surplus Definition
- The sum of PS and CS is referred to as total surplus.
- Total surplus is a measure of net benefits to society from the production and consumption of a good.
Aim of Society in reference to Market efficiency related to Total Surplus
The aim of society and efficient markets is to maximize the total surplus in every market.
Total Surplus Maximisation in reference to use of resources?
If we allocate and use resources so that total surplus is maximized in each market, then we are using the economy’s resources in the most efficient way only at equilibrium point.
Dead Weight Loss
DWL (Deadweight Loss) - Refers to lost total surplus.
