Week 3 Flashcards
What is ELASTICITY?
A measure of how much one economic variable responds to changes in another economic variable
What does the law of demand state?
When price increases, demand decreases.
When price decreases, demand increases.
What is the PRICE ELASTICITY OF DEMAND?
Responsiveness of the quantity demanded to a change in price.
Measured by dividing % change in quantity demanded by % change in price.
Can PED be determined by the slope of the demand curve?
Yes - the slope shows how much quantity demanded changes as price changes.
Why is slope not best measurement to PED?
It is sensitive to units chosen for quantity and price (e.g. gram vs kg). Hence, % change is used.
What is formular for PED?
% change in QD divided by % change in price
Is PED always negative?
Yes, but only the absolute number is considered.
What is ELASTIC DEMAND?
When % change in QD > % change in $
PED > 1
What is INELASTIC DEMAND?
When % change in QD < % change in $
PED > 1
What happens if QD is sensitive to changes in price?
% change in QD > % change in $
PED > 1
ELASTIC
What happens if QD is NOT sensitive to changes in price?
% change in QD < % change in $
PED < 1
INELASTIC
What happens if changes in QD = changes in $?
PED = 1
UNIT ELASTIC
What is UNIT ELASTIC?
When % change in QD = % change in price
PED = 1
What is the MID-POINT FORMULA?
Used to calculate PED
Ensures only have one value for PED btw two points on demand curve
It uses:
- average of inital and final quantity
- average of inital and final price
What is the MID-POINT FORMULA?
PED = (Q2-Q1)/((Q1+Q2)/2) / (P2-P1)/((P1+P2)/2)
What does a flatter demand curve indicate?
A product is more elastic
What does a steeper demand curve indicate?
A product is more inelastic
What is perfectly inelastic demand?
When a change in $ results in no change in QD
QD is not responsive to $ change
Demand curve is VERTICAL
PED=0
What is perfectly elastic demand?
When a change in $ results in an infinite change in QD
QD is indefinitely responsive to $ change
Demand curve is HORIZANTAL
PED=INFINITY
Elastic or inelastic, PED < 1?
Elastic
Elastic or inelastic, PED > 1?
Inelastic
If PED = 1, what is elascity?
Unit elasticity
If PED = 0, what is elascity?
Perfectly inelastic
If PED = infinity, what is elascity?
Perfectly elastic
What are the key determinants of PED?
- availability of substitutes
- time
- luxury vs necessity
- type of market
- share of consumers’ budget
Why is availability of substitutes an determinant of PED?
Because how consumers react to $ changes depends on alternatives
e.g. petrol $ - consumers have few alternatives
Elasticity if a product has more close substitutes?
More elastic
Elasticity if a product has few close substitutes?
Less elastic
Why is passage of time an determinant of PED?
Because it takes time for consumers to adjust their buying habits when $ change
Elasticity if more times passes?
More elastic
Elasticity if less times passes?
Less elastic
Elasticity if a product is a luxury?
More elastic
Elasticity if a product is a necessity?
Less elastic
Elasticity if a narrowly defined market?
More elastic
Because consumers have more alternatives
Elasticity if a broadly defined market?
Less elastic
Because consumers have fewer alternatives
Why is share of consumer budget/spend?
Because low-segment priced products take less share of consumers’ budget/income
Increase in $ therefore negligible impact on a consumer budget
Elasticity if a small % of consumer budget?
Less elastic
Elasticity if a larger % of consumer budget?
More elastic
Total Revenue - what is it?
The total amount received by a seller of a good/service
What is the formula for total revenue?
Unit price x quantity supplied
When demand is inelastic, what direction do price and revenue move in?
Same direction.
Price Increase, Total Revenue Increase
Price Decrease, Total Revenue Decrease
When demand is elastic, what direction do price and revenue move in?
Opposite directions.
Price Increase, Total Revenue Decrease
Price Decrease, Total Revenue Increase
Why does revenue decrease when demand is inelastic and price falls?
Because
- revenue lost from price decrease greater than revenue gained from increase in QD
Why does revenue decrease when demand is elastic and price falls?
Because
- revenue lost from price decrease less than revenue gained from increase in QD
What happens to revenue when product is unit elastic?
Change in $ is exactly offset by a proportional change in QD.
Revenue is not affected.
What is competitive market?
a market with many buyers and sellers
Does a competitive market result in economic efficiency? Why?
Yes
Because:
- MB = MC
- the sum of the consumer surplus and producer surplus are at maximum
What is necessary for economic efficiency?
MB of last unit sold = MC of production
Occurs at Competitive Equilibrum
What is Economic Surplus?
The sum of consumer surplus and producer surplus
What is consumer surplus?
area below demand curve, above equilibrum $
What is producer surplus?
area above the curve, below equilibrum $
What is deadweight loss?
the reduction in economic surplus resulting from market not being in competitve equilibrium
What is consumer surplus?
Measures NET BENEFIT to consumers from buying a particular product
What is producer surplus?
Measures NET BENEFIT to firms from supplying a particular product
What is economic surplus?
the sum of the net benefit to society from the production of particular goods/services
What is economic efficiency of a competitive market?
Equilibrium in a competitive market result in the greatest amount of economic surplus, or the total benefit to society, from the production of good/service
What reduces economic efficiency?
Anything that causes the market for a good/service not to be in competitive equilibrium reduces total benefit to society
What is economic efficiency?
a market outcome in which
1) the MB = MC
2) the sum of the consumer surplus and producer surplus are at maximum
How can taxes affect a product’s market equilibrium?
Because can reduce economic efficiency
What is the true burden of tax?
- the amount consumers/firms pay to the Gov
2. the deadweight loss
What is EXCESS BURDEN?
deadweight loss from tax
When is a tax-efficient?
When it imposes a small excess burden relative to tax revenue raised
What is tax incidence?
The division of tax burden btw
- buyers, and
- sellers
What is Elasticity?
a measure of how much one economic variable responds to changes in another e/variable
What is Price Elasticity of Demand?
the responsiveness of QD to change in $
What is formula for Price Elasticity of Demand?
PED = % change in QD / % change in $
What is Unit Elastic Demand?
PED = 1
When the % change in QD = % change in price
What is Elastic Demand?
PED > 1
When the % change in QD > % change in price
What is Inelastic Demand?
PED < 1
When the % change in QD < % change in price
What is Perfectly Elastic Demand?
PED = Infinity
when change in $ results in INFINITE CHANGE in QD
What is Perfectly Inelastic Demand?
PED = O
when change in $ results in NO CHANGE in QD
What are the determinates of demand?
- subsitutes
- timeframe
- income share
- luxury v. necessity
- breadth of market
If there are MORE substitutes, then elasticity is…
MORE ELASTIC
If there are timeframe is LONGER, then elasticity is…
MORE ELASTIC
If there are price takes GREATER SHARE of consumer income, then elasticity is…
MORE ELASTIC
If there the product is MORE LUXURY , then elasticity is…
MORE ELASTIC
If there the MARKET IS NARROWER substitutes, then elasticity is…
MORE ELASTIC
What is total revenue?
total amount received by sellers of goods/services
What is formula for total revenue?
TR = Price x Quantity
What is the TOTAL REVENUE TEST?
a method of estimating the price of elasticity of demand by observing the change in TR resulting from price change
If Inelastic and price increases,
TR increases
If Inelastic and price decreases,
TR decreases
If Elastic and price increases,
TR decreases
If Elastic and price decreases,
TR increases
If Unit Elastic and price changes,
TR is not affected
If Elastic and price changes, TR moves in the ____ direction
Opposite
If Elastic and price changes, TR moves in the ____ direction
Same
If Unit Elastic and price changes, TR moves in the ____ direction
No - it is unaffected
What is consumer surplus?
benefit/value for consumers above $ paid
What is producer surplus?
how much more producers are getting relative to their opportunity cost
