Unit 3: Price Elasticity Flashcards
Price elasticity
The measure of the responsiveness to the percent chance in quantity demanded or supplied to changes in price
Or how much more or less someone is going to buy/sell something when price changes
Price elasticity of demand
Measurement of how much the quantity demanded responds to a change in price
Necessity good
A good for which consumption tends to show a little to no response to change in price (ex. Epi pen)
Luxury good
A good for which consumption tends to show a significant response to a change in price (ex. Pizza)
When a good is elastic, what happens to price, QD and total revenue?
Decrease in price increases QD, Increases in total revenue
Increase in price decreases QD, Decreases total revenue
When a good is inelastic, what happens to price, QD and total revenue?
Decrease in price increases QD, Increases in total revenue
Increase in price decreases QD, Decreases total revenue
Ratio of change-elastic or inelastic? Greater than 1 Less than 1 =1 0 Undefined/infinity
Elastic Inelastic Unit elastic Perfectly inelastic (vertical line) Perfectly elastic (horizontal line)
Ratio of change-substitutes or complements?
+,-
+: substitute
-: complement
Ratio of change-normal good or inferior good?
+,-
+: normal
-: inferior
How to calculate price elasticity of demand
QD<1
QD>1
change in % QD/ % change in price
QD<1: INELASTIC
QD>1: ELASTIC
How to calculate cross price elasticity of demand
QD<1
QD>1
change % QD of good A/ Change % price of good B
QD<1: INELASTIC, substitutes
QD>1: ELASTIC, complements
How to calcuate income elasticity of demand
QD<1
QD>1
change % QD/change % Income
QD<1: INELASTIC, inferior
QD>1: ELASTIC, normal
A good is unit elastic if
decrease in price-increase in Qd-no change in TR
increase in price-decrease in !d-no change in TR
A good is elastic if
increase in price-decrease in Qd-decrease in TR
decrease in price-increase in Qd-increase in TR
A good is inelastic if
increase in price-decrease in Qd-increase in TR
decrease in price-increase in Qd-decrease in TR
TR=
P x Q
Price celiling
a legal maximum on the price at which a good can be sold
Price floor
a legal minimum price for which a good can be sold
If the price ceiling is ABOVE or BELOW equilibrium, is it binding or not binding?
Does a binding ceiling create a shortage or surplus?
Has to be BELOW in order to be binding
Creates a shortage
If the price floor is ABOVE or BELOW equilibrium, is it binding or not binding?
Does a binding ceiling create a shortage or surplus?
Has to be ABOVE in order to be binding
Creates a surplus
Consumer surplus
Difference between the resource costs and price that consumer pays
Producer surplus
(amount seller is paid for a good) - (what the seller is willing to sell at)
Total surplus
(consumer surplus) + (producer surplus)
Efficient market
market that is opperating at the price and quantity with the most total surplus
aka allocatively efficient
Changes in price affecting CS and PS
Price increases-CS decreases-PS increases
Price decreases-CS increases-PS decreases
Taxes in a perfectly competitive market
- taxes are almost always split between producer and consumers (except if S or D is perfectly elastic/inelastic)
- burden on tax falls more heavily on the part of the market that is more inelastic
efficiency vs. equity
How do price controls affect both?
efficientcy: maximizing total surplus received by all members of society
equity: fairness of distribution of well-being among society
Price contrls DECREASE efficiency but INCREASE equity
Lump-sum tax
a tax that is an equal quantity for every person
ex. everyone pays $50, tax with cars, city tax/overnigh tax (tourism)
Progressive tax
a tax that increases in % as income rises
ex. high income pays 40%, low income pays 30%
Regressive tax
a tax that decreases in percentage as income rises
ex. high income pays 20%, low income pays 30%
Proportional tax (flat tax)
a tax for which each taxpayer pays an equal proportion of their income
ex. everyone pays 10% of their income in taxes
The Laffer curve
the idea that at a certain point, decreasing the tax % actually increases tax revenue
Price elasticity of supply
change % in QS/change % in price
Why is a price floor ineffective under the equilibrium price?
Forces of S and D will keep price at equilibrium above the floor, so a minimum is not needed
Why is a price ceiling ineffective above the equilibrium price?
Forces of S and D will keep price at equilibrium below ceoiling so maximum is not needed
Are price controls inefficient even if they are not binding
No, they’re still efficient because they do not cause deadweight loss if they are not binding
Deadweight loss
Fall in total surplus due to market distortion
Why is an effective price control inefficient?
Because it causes deadweight loss
What happens to consumer surplus when price increases?
It decreases because consumers are no longer saving as much money with their purchases as price has increased
What happens to producer surplus when price increases?
Increases because price has increased and costs have stayed the same, so profits decrease
