week 3 (chapter 5 and 6) Flashcards
prices
signals that guide the allocation of resources, and how things are going to be priced
-leads to price gouging
price gouging
taking advantage of consumers, charging different prices to different consumers
elasticity
how much one variable responds to a change in another variable
price elasticity of demand
how much the quantity demanded of a good responded to a change in price of that good
elasticity of demand
percentage change in quantity demanded / percentage change in price
elastic demand
quantity demanded responds substantially to change in price
inelastic demand
quantity demanded responds slightly to change in price
ex. gas, oil, sanitary products
what does the curve look like when the demand is elastic?
flatter
what does the curve look like when the demand is inelastic?
steeper
is the elasticity of demand always negative?
YES - but we use the absolute value for it
magnitude of the change in price reaction
< 1 = inelastic
> 1= elastic
= 1 unit elastic
= 0 perfectly inelastic
= infinity perfectly elastic
perfectly inelastic
= 0
customer sensitivity to price change is none
ex. food as a whole, clothes as a whole
things that you need
vertical
inelastic demand
< 1
customer sensitivity is relatively low, demand curve is steep
ex. 22% increase in price leads to 22% decrease in quantity demanded
unit elastic demand
= 1
customer sensitivity is intermediate
ex. a 22% increase in price leads to a 67% increase in quantity demanded
elastic demand
> 1
customer sensitivity is relatively high, and demand curve is flatter
ex. 22% increase in price leasd to 67% decrease in quantity demanded
perfectly elastic demand
= 0
customer sensitvity is extreme, and curve is horizontal
ex. at any price above a 4 dolalr quantity demanded is zero
no change in price, so the price stays fixed
ex. 1 dollar arizonas
determinants of elasticity
- availability of substitutes
- time horizon
- category of product
- luxuries vs. necessities
- purchase size
how to find percentage change
use the midpoint method
(q2-q1)/(q2+q1)/((p2-p1)/(p2+p1)/2) x 100
then to find the elasticty of demand by finding percentage change at first…
percentage of quantity demanded/percentage of price change
availability of substitutes
fewer substitues make it harder for consumers to adjust quantity when price changes
demand is more inelastic
time horizon
less time to adjust to find substitutes or make alterations means that there is lower elasticity
elasticity will become larger as time goes on
category of product
the less specific the classification, the fewer substitutes there are (making demand inelastic) and vice versa
ex. the elasticity of demand is higher for lettuce (very specific) than it is for food in general (broad)
necessities vs. luxuries
for necessities, we do not change quantity much as the price changes
for luxuries, we are more sensitive to price changes
purchase size
we are less sensitive to price changes when the good feels cheap - lower price sensitivity
we are equally more sensitive to price changes when the good feels expensive - higher price elasticity
linear demand elasticity
along the curve, the elasticity is different because prices are lower at one end than at the other
how to calculate revenue
price x quantity
elasticity of demand affects revenue when good price changes
- if elasticity of quantity demanded is larger than the price, there is going to be a drop in revenue
- if elasticity of quantity demanded is smaller than the price, there is going to be a rise in revenue
price elasticity of supply
how much the quantity supplied of a good responds to a change in price of that good
- directly proportional relationship between quantity supplied and price
elastic supply
when quantity supplied responds slightly to change in price
inelastic supply
when quantity supplied responds slightly to change in price
determinants of elasticity
- change in per unit costs (input prices) with increased production
- time horizon
- share of market for inputs
- geographic scope
change in per unit costs
if production costs more, there is going to be less sensitivity to changes in prices and vice versa
time horizon
immediately following a price increase, producers can only expand output using their current capacity (making supply inelastic)
over time producers can expand their capacity (making supply elastic)
when prices change in the supply, it will be harder to find another supplier in the short term, but easier in the long run
more sensitivity to price in the short run, but less in the long run
share of market for inputs
supply is elastic when the industry can be expanded without causing a big increase in the demand (and price) for the industry’s inputs)
supply inelastic when industry expansion causes a significant increase the demand/price for inputs
if there is a large market share of a good or industry, there is going to be way more sensitivity when there are changes in the price
more people in industry = less sensitivity to changes in price
less people in the industry = more sensitivity to changes in price
geographic scope
the wider the scope of the market, the less elastic the supply
if you are focusing on one particular region any small change will drastically affect how much you are producing
input prices
any sort of labor costs, manufacturing costs, paying workers, etc.
income elasticity of demand
percent change in quantity demanded/percentage change in income
for normal goods, income elasticity > 0
- when income goes up we expect the demand to go up
for inferior goods, income elasticity < 0
- when income goes up, we expect the demand for that good to go down
cross price elasticity
measures the response of the demand of one good change according to the price of another good
percentage change in quantity demand for good 1/ percentage change in price of good 2
substitutes = positive for demand and positive for price
complements = positive for demand and negative for price
price ceiling
legal maximum on the price of a good or service
- used to maintain the purchasing power of consumers
- legal cap on prices
what happens when the price ceiling is below the equilibrium price?
there is a binding constraint and causes a shortage of the supply because so many people want the good
effects of price ceilings below equilibrium prices
- shortages
- reduction in product quality
- wasteful lines and other costs of search
- loss of gains from trade
- misallocation of resources
misallocation of resources
prices controls distort signals and eliminate incentives leading to a misallocation of resources
the people who need it the most might not be able to get it, because of the surplus of the less expensive goods
loss of gains from trade
price ceilings set below the market price cause quantity supplied to be less than the market quantity
price ceilings create deadweight loss by forcing quantity supplied below market quantity
buyers and sellers would both benefit from trade at a higher price but cant
deadweight
the total of lost consumer and producer surplus when all mutually profitable gains from trade are not exploited
wasteful lines and costs of search
if prices are not allowed to rise, buyers must compete with each other in other ways
ex. bribes, using bots to buy things
reduction in product quality
when prices are controlled they cant profit off of supplying more expensive product
producers cut corners to find a cheaper solution, to where they can make a profit off of the ceiling
price floor
a legal minimum on the price of a good or service (e.g. minimum wage)
is a price floor below the equilibrium price binding?
NO - has no effect on the market outcome
four effects of price floors
- surpluses of goods
- loss of gains from trade
- wasteful increases in quality
- misallocation of resources
price floor causing wasteful increases in quality
higher quality raises cost and reduces seller proft
buyers get a higher quality but would prefer lower price
price floor encourages sellers to waste resources; higher quality than buyers are willing to pay for
price floors affecting the misallocation of resources
- allows high cost firms to operate
- prevents low cost firms from entering the industry
ex. regulation prevented southwest from entering the national market
