MIZZOU Econ 1014 Exam 2

Elasticities

Measure the level of responsiveness to different types of market changes

Price Elasticity of Demand

How responsive consumers of a particular good are to changes in price of that good

The less responsive to price changes we are...

the steeper our demand is

The more responsive we are to price changes...

the flatter our demand is

Elasticity of Demand (E.d)

=(%change in quantity demanded)/(%change in price)

Percentage Change

(new-old)/(old) all times 100%

Price elasticity of demand is always...

NEGATIVE!

When comparing price elasticities...

Use Absolute Value

Consumers are more responsive to price change when they have more...

Substitutes

If it's a necessity...

consumers are less elastic

If it's a luxury

consumers are more elastic

How responsive demanders are to price changes depends on:

luxury vs. necessity

specific vs. general category

Long run vs. short run

Price Inelastic

Abs Value E.d. is less than one

Price elastic

Abs Value E.d. is greater than one

Unit Price elastic

Abs Value E.d.=1

Perfectly Price Inelastic

Abs Value E.d.=0

Never a change in Qd

Vertical line

Perfectly Price Elastic

Abs Value E.d.=infinity

horizontal line

Point Slope E.d.

(1/slope demand curve)(P/Q)

Sales Revenue

(price per unit)(# of unit sold)

If |E.d.| less than 1

P Incr. and TR Incr.

If |E.d.| greater than 1

P Decr. and TR Incr.

If |E.d.|=1

Price is MAXIMIZING REVENUE PRICE

Price Elasticity of Supply

Producer's price responsiveness

E.s.=

(%change quantity supplied)/(%changeP)

Elasticity Comparison

same as before

Income Elasticity of Demand

How responsive are consumers of some good to change in their income

Normal Good

Higher income, higher demand

E.i.=

(%changeDemand)/(%changeIncome)

or

(%change Qd at original price)/(%change Income)

Income elasticity may be

POSITIVE OR NEGATIVE

E.i. is positive means

normal good

E.i. is negative means

inferior good

Complementary Goods

Goods used together

Substitute goods

Goods that are used to replace each other

Cross-price elasticity of demand

(%Change in demand for good X)/(%change of Price for good Y)

Consumer's Reservation Price

Highest price a consumer is willing to pay for a product

Rationing device?

Market Price

Consumer Surplus

Measure of how much economic surplus a consumer has earned after making his purchase decision.

CS=

Reservation Price-Price paid

Producer Surplus

Economic surplus that goes to the producer

PS=

Price received-Res price

PS on graph

Area above supply curve and below the price received

CS on graph

Area under demand curve and above price paid

TS=

CS-PS

Reduction on TS on graph/DWL

Triangle

Price Floor

Legally set minimum placed on market price

Binding price floor

Set above market equilibrium price

Resource Misallocation

Difference between what should be produced and consumed and what is produced and consumed

DWL

Reduction in economic surplus

Price ceiling

Legally set max price for the market

Binding price ceiling

Legally set max price above the equilibrium price

Tax on suppliers

Shifts supply curve left

How Tax Burden is Shared

Whoever is most responsive to price change pays less and vice versa

Tax Revenue(TR)=

(tax per hour of labor)(number of hours of employment)

Tax on Demanders

Shifts demand curve left

Subsidies

Tend to encourage market activity because they lower the cost of participating in the market.

How subsidy is shared

Whoever is more responsive to price changes gets less of the subsidy and vice versa

Subsidy to supplier

Shifts supply curve to the right

Subsidy to Demanders

Shifts the demand curve to the right