Topic 3 - Applications of the Demand and Supply: Positive Considerations

Question 1

What is “Elasticity”?

Answer 1

Elasticity is a measure of how much buyers and sellers will respond to changes in market conditions.

Elasticity is usually considered in respect to a specific condition.

Question 2

Define “Price Elasticity of Demand”?

Answer 2

Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good.

Question 3

How is “Price Elasticity of Demand” calculated?

Answer 3

Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price.

This almost always returns a negative value. So take the magnitude.

Question 4

What does it mean for something to be “Inelastic”?

Answer 4

This means the elasticity is less than 1.

Question 5

What does it mean for something to be “Elastic”?

Answer 5

This means the elasticity is greater than 1.

Question 6

What does it mean for something to be “Perfectly Inelastic”?

Answer 6

This means the elasticity equals 0.

Question 7

What does it mean for something to be “Perfectly Elastic”?

Answer 7

This means the elasticity tends towards infinity.

Question 8

What does it mean for something to be “Unit Elastic”?

Answer 8

This means the elasticity is exactly 1.

Question 9

What is the definition of “Total Revenue”?

Answer 9

Total revenue is the amount paid by buyers and received by sellers of a good, calculated as the price of the good times the quantity sold: TR = P x Q

Question 10

Define “Income Elasticity of Demand”?

Answer 10

The income elasticity of demand measures how much the quantity demanded of a good responds to a change in consumers’ income.

Question 11

How is “Income Elasticity of Demand” calculated?

Answer 11

It is calculated by dividing the percentage change in the quantity demanded by the percentage change in income.

Question 12

What does it mean if the “Income Elasticity of Demand” is greater than 0?

Answer 12

This means that the good is considered a normal good.

Question 13

What does it mean if the “Income Elasticity of Demand” is less than 0?

Answer 13

This means that the good is considered an inferior good. As a person’s income reduces they are likely to buy more of an inferior good rather than a normal good, leading to an increased demand.

Question 14

Define “Cross-Price Elasticity of Demand”?

Answer 14

The cross-price elasticity of demand measures how much the quantity demanded of a good changes as the price of another good changes.

Question 15

How is “Cross-Price Elasticity of Demand” calculated?

Answer 15

Cross-price elasticity of demand is calculated by dividing the percentage change in the quantity demanded of a good by the percentage change in the price of a different good.

Question 16

What is “Cross-Price Elasticity of Demand” used for?

Answer 16

Cross-price elasticity of demand is used to find the relationship between different goods in a market be they substitutes, complements, or unrelated.

Question 17

What does it mean if the “Cross-Price Elasticity of Demand” is greater than 0?

Answer 17

This means that the two goods being evaluated are complements to each other. When more of one is bought, it correlates with more of the other being bought.

Question 18

What does it mean if the “Cross-Price Elasticity of Demand” is less than 0?

Answer 18

This means that the two goods are substitutes for each other. When one good’s price increases people are more likely to find a substitute good to buy instead and vice-versa.

Question 19

What does it mean if the “Cross-Price Elasticity of Demand” is exactly 0?

Answer 19

The two goods being observed are unrelated.

Question 20

Define “Price Elasticity of Supply”?

Answer 20

Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good.

Question 21

How is “Price Elasticity of Supply” calculated?

Answer 21

Price elasticity of supply is calculated by dividing the percentage change in the quantity supplied by the percentage change in price.

Question 22

What is a “Price Ceiling”?

Answer 22

A price ceiling is a legal limit on the maximum price at which a good can be sold.

Question 23

What is a “Price Floor”?

Answer 23

A price floor is a legal limit on the minimum price at which a good can be sold.

Question 24

Rent Control is…

Answer 24

The best way to destroy a city other than bombing.

Question 25

Define “Tax Incidence”

Answer 25

Tax incidence is the study of who bears the burden of a tax.

Question 26

How does a tax levied on buyers shift the demand curve?

Answer 26

It shifts the demand curve down by the value of the tax.

Question 27

How does a tax levied on sellers shift the supply curve?

Answer 27

It shifts the supply curve up by the value of the tax.

Question 28

How does the quantity traded of an item change after a tax is introduced?

Answer 28

The quantity traded will reduce, as buyers have to pay more per item (reducing demand) and/or sellers receive less per item (reducing supply).

Question 29

How does the tax incidence relate to who is paying the tax?

Answer 29

It doesn’t, they are independent, as whoever is being taxed changes their behaviour, both sides end up paying the same amount of the tax regardless.

Question 30

Who does the burden of tax fall more heavily on? Sellers or Buyers?

Answer 30

Whoever has the more inelastic curve. As they have less ability to change behaviour.