section 9

substitution effect

when consumers react to an increase in a good's price by consuming less of that good and more of other goods

the change in the quantity of that good demanded as the consumer substitutes the good that has become relatively cheaper for the good that has become relatively more expensive

income effect

the change in consumption resulting from a change in real income

the change in the quantity of that good demanded that results from a change in the consumer's purchasing power when the price of the good changes

price elasticity of demand

a measure of the sensitivity of demand to changes in price

the ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve

% change in quantity demanded

change in quantity demanded/ initial quantity demanded x 100

% change in price

change in price/initial price x 100

midpoint method

a technique for calculating the percent change

dividing the change in a variable by the average, or midpoint, of the initial and final values of that variable

price elasticity of demand equation

% change in quantity demanded / % change in price

perfectly inelastic

when the quantity demanded does not respond at all to changes in the price.

the demand curve is a vertical line

perfectly elastic

when any price increase will cause the quantity demanded to drop to zero.

the demand curve is a horizontal line

elastic

price elasticity of demand is greater than 1

inelastic

price elasticity of demand is less than 1

unit elastic

price elasticity of demand is exactly 1

total revenue

the total value of sales of a good or service.

It is equal to the price multiplied by the quantity sold

total revenue equation

Price x Quantity sold

no effect on total revenue

fall in price has _____________ when the demand is unit elastic

reduces total revenue

fall in price ________ when the demand is inelastic

increases total revenue

fall in price _________ when the demand is elastic

S - substitutes
P - proportion of income
L - luxury vs necessity
A - addictive or habit forming
T - time

the determinants of price elasticity

cross price elasticity of demand

the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good

between two goods measures the effect of the change in one good's price on the quantity demanded of the other good. It is equal to the percent change in the quantity demanded of one good divided by the percent change in the other good's price

income elasticity of demand

the percent change in the quantity of a good demanded when a consumer's income changes divided by the percent change in the consumer's income

income-elastic

the income elasticity of demand for that good is greater than 1

income-inelastic

the income elasticity of demand for that good is positive but less than 1

price elasticity of supply

a measure of the responsiveness of the quantity of a good supplied to the price of that good. it is the ratio of the percent change in the quantity supplied to the percent change in the price as we move along the supply curve

perfectly inelastic supply

when the price elasticity of supply is zero, so that changes in the price of the good have no effect on the quantity supplied. supply curve is a vertical line

perfectly elastic supply

the quantity supplied is zero below some price and infinite above that price. supply curve is a horizontal line

cross price elasticity of demand equation

% change in quantity of A demanded / % change in price of B

income elasticity of demand equation

%change in quantity demanded/ %change in income

price elasticity of supply equation

% change in quantity supplied / % change in price

compelment

negative cross price elasticity is a

substitute

positive cross price elasticity is a

inferior good

negative income elasticity is a

normal good

positive income elasticity is a