Micro Test 2

elasticity

measures how much one variable responds to changes in another variable; a numerical measure of the responsiveness of Qd or Qs to one of its determinants

price elasticity of demand

measures how much Qd responds to a change in P; measures price sensitivity of buyer’s demand

price elasticity of demand formula

(% change in Qd) / (% change in P)

positive numbers

what do we report ALL price elasticities as?

midpoint method

((end value - start value) / midpoint) x 100 -OR- ((Q1-Q2) / (Q1+Q2)/2)) x 100

midpoint method for price

( (P1-P2) / ((P1+P2)/2) ) x 100

slope of demand curve

What is the elasticity of the demand curve related to? (DOES NOT mean equal to slope of demand curve)

elasticity is bigger

if a curve is flatter, what does this mean for elasticity?

elasticity is smaller

if a curve is steeper, what does this mean for elasticity?

perfectly inelastic

elasticity = 0 (same for demand and supply)

inelastic

elasticity < 1 (same for demand and supply)

unit elastic

elasticity = 1 (same for demand and supply)

elastic

elasticity > 1 (same for demand and supply)

perfectly elastic

elasticity = infinity (same for demand and supply)

determinants of demand elasticity

1) extent to which close substitutes are available, 2) whether good is a necessity or a luxury, 3) how broadly (inelastic) or narrowly (elastic) the good is defined, 4) time horizon

higher because there are more choices

is elasticity higher or lower in the long run and why?

total revenue formula

P x Q

inverse (P goes up, TR goes down + P goes down, TR goes up)

if demand/supply is elastic, what is the relationship between price and total revenue?

direct (P goes up, TR goes up + P goes down, TR goes down)

if demand/supply is inelastic, what is the relationship between price and total revenue?

price elasticity of supply

measures how much of Qs responds to a change in P; measures seller’s price sensitivity; % change in Qs / % change in P

determinants of supply elasticity

1) ability to change amount produced, 2) short run vs. long run

elastic supply

easy to change quantity

inelastic supply

difficult to change quantity

long run

is elasticity of supply greater in the long run or the short run?

income elasticity of demand

measures the response of Qd to a change in consumer income; used to determine if good is normal or inferior ( + = normal, - = inferior)

cross price elasticity of demand

measures the response of demand for one good to changes in price of another good; used to determine if goods are substitutes or complements (+ = substitutes, - = complements)

price controls and taxes

what are two government policies that can alter the private market outcome?

price ceiling and price floor

what are two main price controls?

price ceiling

a legal maximum on the price of a good or service

rent control

what is an example of a price ceiling?

price floor

a legal minimum on the price of a good or service

minimum wage

what is an example of a price floor

taxes

government can make buyers or sellers pay a specific amount on each unit bought/sold

not binding

if the price ceiling is above the equilibrium price it has no effect on the market outcome. what is this term?

binding constraint

if the price ceiling is below the equilibrium price it puts constraints on price, causing a shortage. what is this term?

price elastic

are supply and demand more price elastic or inelastic in the long run?

shortages

what causes sellers to ration goods among buyers?

long lines and discrimination according to sellers’ biases

what are two rationing mechanisms?

goods do not go to buyers who value them most

why are rationing mechanisms considered unfair and inefficient?

when prices are not controlled

when would rationing mechanisms ACTUALLY be efficient?

not binding

if price floor is below the equilibrium price it has no effect on the market outcome. what term is this?

binding constraint

if the price floor is above the equilibrium it puts constraint on the wage, which causes a surplus. what term is this?

taxes

government can levy them; can make buyers AND sellers pay tax; can be % of the good’s price or a specific amount for each unit sold

shifts it left by the amount of tax

a tax on buyers does what to the demand curve?

exact tax

what is the difference between Pc and Ps?

tax incidence

how the burden of a tax is shared among market participants

burden to buyer

difference between original equilibrium price and Pc

burden to seller

difference between original equilibrium price and Ps

yes

do buyers and sellers both share burden of tax?

shifts it left by the amount of the tax

what does a tax on sellers do to the supply curve?

tax wedge

drives a wedge between the price the buyer’s pay and the price sellers receive

elasticity of supply and demand

what determines how the tax incidence is divided between the buyer and the seller?

buyers

if demand is inelastic, who bears most of the incidence tax burden?

sellers

if demand is elastic, who bears most of the incidence tax burden?

allocation of resources

1) how much of each good is produced, 2) which producers produce it, 3) which consumers consume it

welfare economics

studies how the allocation of resources affects economic well-being

willingness to pay

the maximum amount the buyer will pay for a good; measures how much a buyer values a good

don’t buy

P > WTP

buy

P < WTP

marginal buyer

the buyer who would leave the market if P were any higher

WTP

at any quantity, the height of the demand curve is the _____ of the marginal buyer

consumer surplus

the amount a buyer is willing to pay minus the amount the buyer actually pays (CS = WTP - P)

no

is consumer surplus ever negative?

under the demand curve + above the price

total consumer surplus equals the area of what?

gets bigger

as price falls, consumer surplus ….

reduces it

what does higher price do to consumer surplus?

CS falls

what does buyers leaving the market do to consumer surplus?

WTP

the demand curve represents ____ for all buyers in the market

cost

the value of everything a seller must give up to produce a good (i.e. opportunity cost)

if price exceeds cost

in what setting will a seller produce and sell a good/service?

marginal seller

the seller who would leave the market if the price were any lower

cost of the marginal seller

at each quantity, the height of the supply curve is the…..

don’t sell

P < C

sell

P > C

producer surplus

the amount a seller is paid for a good minus the seller’s cost; PS = P - cost

no

is producer surplus ever negative?

area above the supply curve + under the price

what does total PS equal in area?

buyers’ gains from participating in the market

CS = (value to buyers) - (amount paid by buyers) = ???

sellers’ gains from participating in the market

PS = (amount received by sellers) - (cost to sellers) = ???

(value to buyers) - (cost to sellers)

total surplus = CS + PS = total gains from trade in a market = ???

efficiency

total surplus = (value to buyers) - (cost to sellers)

when is allocation of resource

maximizes it

what does market equilibrium quantity do to total surplus?

equilibrium with no tax

price = Pe, quantity = Qe

equilibrium with tax

• buyers pay Pc

• sellers receive Ps

• Quantity = Qt

revenue from tax

$T x Qt

(without tax) CS = what letters

(without tax) PS = what letter on

0

(without tax) tax revenue = ??

A + B + C + D + E + F

(without tax) total surplus = ?

A

(with tax) CS = what letter on tax graph?

F

(with tax) PS = what letter on tax graph?

B + D

(with tax) tax revenue = ???

A + B + D + F

(with tax) total surplus = ??????

C + E

what does tax reduce total surplus by?

no

should it be assumed that CS and PS are equal?

deadweight loss

C + E; the fall in total surplus that results from a market distortion, such as tax

those with the smallest DWL

which goods or services should gov tax to raise the revenue it needs?

depends on price elasticity of supply and demand

when is the DWL small vs. large?

harder

when supply is inelastic is it harder or easier for firms to leave the market?