CH5- Elasticity

Elasticity

A measure of the responsiveness of the quantity demanded or quantity supplied to a change in one of its determinants.

Price elasticity of demand

A measure of how much the quantity demanded of a good responds to a change in its price, calculated as the percentage change in quantity demanded divided by the percentage change in price.

Total revenue

The amount paid by buyers and received by the sellers of a good, calculated as the price of the good times the quantity sold (P × Q).

Income elasticity of demand

A measure of how much the quantity demanded of a good responds to a change in consumers' income, calculated as the percentage change in quantity demanded divided by the percentage change in income.

Cross-price elasticity of demand

A measure of how much the quantity demanded of one good responds to a change in the price of another good, calculated as the percentage change in the quantity demanded of the first good divided by the percentage change in the price of the second good.

Price elasticity of supply

A measure of how much the quantity supplied of a good responds to a change in its price, calculated as the percentage change in quantity supplied divided by the percentage change in price.

Elastic

Describes demand or supply that responds substantially to a change in price (elasticity greater than 1).

Inelastic

Describes demand or supply that responds only slightly to a change in price (elasticity less than 1

Unit elastic

Describes demand or supply for which the percentage change in quantity exactly equals the percentage change in price (elasticity equal to 1).

Perfectly inelastic

Demand or supply with an elasticity of zero; the quantity does not respond at all to price. Graphed as a vertical line.

Perfectly elastic

Demand or supply with an elasticity approaching infinity; tiny price changes cause huge quantity changes. Graphed as a horizontal line.

Midpoint method

A technique for calculating percentage change that divides the change in a variable by the average (midpoint) of the initial and final values, giving the same elasticity regardless of the direction of change.

Engel's Law

The observation that as a family's income rises, the percentage of income spent on food declines, implying an income elasticity of demand for food that is less than one.

What does elasticity measure?

The responsiveness of quantity demanded or supplied to a change in one of its determinants

How is the price elasticity of demand calculated?

Percentage change in quantity demanded divided by percentage change in price

Why does the midpoint method give the same elasticity regardless of direction?

Because it divides the change by the average of the initial and final values, not just the initial value

Goods with many close substitutes tend to have:

More elastic demand, since consumers can easily switch to another good

Necessities (like doctor visits) tend to have:

Inelastic demand, since consumers can't easily cut back

How does defining a market more narrowly affect elasticity of demand?

Narrower markets have more elastic demand because closer substitutes exist

How does the time horizon affect the price elasticity of demand?

Demand becomes more elastic over longer time periods, as consumers find substitutes

If a 10% price increase causes a 20% decrease in quantity demanded, what is the price elasticity of demand?

2 (elastic)

On a graph, what does a flatter demand curve at a given point indicate?

Greater price elasticity of demand

What shape is a perfectly inelastic demand curve?

A vertical line

What shape is a perfectly elastic demand curve?

A horizontal line

How is total revenue calculated?

Price multiplied by quantity (P × Q)

If demand is inelastic, what happens to total revenue when price rises?

Total revenue increases

If demand is elastic, what happens to total revenue when price rises?

Total revenue decreases

If demand is unit elastic, what happens to total revenue when price changes?

Total revenue stays the same

Along a linear demand curve, where is demand elastic?

At points with high price and low quantity

Along a linear demand curve, where is demand inelastic?

At points with low price and high quantity

A normal good has what kind of income elasticity of demand?

Positive, since quantity demanded rises when income rises

An inferior good has what kind of income elasticity of demand?

Negative, since quantity demanded falls when income rises

If two goods are substitutes, what is the sign of their cross-price elasticity of demand?

Positive, since a price increase in one raises demand for the other

If two goods are complements, what is the sign of their cross-price elasticity of demand?

Negative, since a price increase in one lowers demand for the other

How is the price elasticity of supply calculated?

Percentage change in quantity supplied divided by percentage change in price

Why does beachfront land have inelastic supply?

Because the amount of land is fixed and sellers can't easily produce more of it

Why do manufactured goods like books and cars tend to have elastic supply?

Because firms can run factories longer or build new ones in response to price changes

How does the time horizon affect the price elasticity of supply?

Supply becomes more elastic over longer periods, as firms can adjust capacity and entry/exit

What shape is a perfectly inelastic supply curve?

A vertical line

What shape is a perfectly elastic supply curve?

A horizontal line

In the "good news for farming" example, why does a technological advance that increases wheat supply hurt farmers' total revenue?

Because demand for wheat is inelastic, so the price falls proportionately more than quantity rises

Why could OPEC only keep oil prices high in the short run, not the long run?

Because supply and demand for oil are inelastic in the short run but become more elastic in the long run

Why might drug interdiction (reducing drug supply) increase total spending on drugs and drug-related crime?

Because demand for drugs is inelastic, so a price increase raises total revenue paid by addicts

How does drug education differ from drug interdiction in its effect on the drug market?

Drug education shifts the demand curve left, reducing both price and quantity (and total spending)

______ measures the responsiveness of quantity demanded or supplied to a change in one of its determinants.

elasticity

The price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in ______.

price

The ______ method calculates percentage change by dividing the change by the average of the initial and final values.

midpoint

Total revenue equals price multiplied by ______.

quantity

If demand is ______, an increase in price causes total revenue to increase.

inelastic

If demand is ______, an increase in price causes total revenue to decrease.

elastic

If demand is ______, total revenue stays the same regardless of price changes.

unit elastic

A demand curve that is a vertical line has an elasticity of ______. Answer:

zero (perfectly inelastic)

A demand curve that is a horizontal line has an elasticity approaching ______.

infinity (perfectly elastic)

The ______ elasticity of demand measures how quantity demanded responds to a change in consumer income.

income

Goods for which demand increases as income rises are called ______ goods.

normal

Goods for which demand decreases as income rises are called ______ goods.

inferior

The ______ elasticity of demand measures how the quantity demanded of one good responds to a change in the price of another good.

cross-price

If two goods are substitutes, their cross-price elasticity of demand is ______.

positive

If two goods are complements, their cross-price elasticity of demand is ______.

negative

The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in ______.

price

Supply tends to be more elastic in the ______ run than in the short run.

long

Demand tends to be more elastic when a market is defined more ______ (broadly/narrowly).

narrowly

Elasticity measures responsiveness of quantity to a change in price or another determinant.

True

The price elasticity of demand is always reported with a negative sign in this textbook's convention.

False

The midpoint method gives a different elasticity depending on whether you go from point A to B or B to A.

False

Goods with many close substitutes tend to have inelastic demand.

False

Necessities tend to have inelastic demand.

True

Luxuries tend to have elastic demand.

True

Narrowly defined markets (like "vanilla ice cream") tend to have more elastic demand than broad ones (like "food"

True

Demand tends to become less elastic as more time passes after a price change.

False

A steeper demand curve at a given point indicates a smaller price elasticity of demand

True

A perfectly inelastic demand curve is horizontal.

False

A perfectly elastic demand curve is horizontal.

True

Total revenue equals price times quantity.

True

When demand is inelastic, raising price increases total revenue.

True

When demand is elastic, raising price increases total revenue.

False

A linear demand curve has constant elasticity at every point.

false

At low prices and high quantities on a linear demand curve, demand is inelastic

true

At high prices and low quantities on a linear demand curve, demand is elastic.

true

Normal goods have a negative income elasticity of demand.

false

Inferior goods have a positive income elasticity of demand.

false

Substitute goods have a negative cross-price elasticity of demand.

False

Complementary goods have a negative cross-price elasticity of demand.

true

Supply tends to be more elastic in the long run than in the short run.

true

Beachfront land has a highly elastic supply.

false

A vertical supply curve represents perfectly elastic supply.

false

OPEC was able to keep oil prices high indefinitely because both supply and demand stayed inelastic forever.

false

An increase in wheat supply due to new technology, combined with inelastic demand for wheat, causes farmers' total revenue to fall.

true

Drug interdiction (reducing drug supply) combined with inelastic demand for drugs can increase the total amount drug users spend on drugs.

true

Drug education (reducing drug demand) reduces both price and quantity, so total spending on drugs falls.

true

E=0 (Elasticity classification)

Perfectly inelastic, vertical line

0 < E < 1 (Elasticity classification)

inelastic, steep curve

E = 1 (Elasticity classification)

Unit Elastic

E > 1

Elastic, flat curve

E = ∞

Perfectly elastic, horizontal line

Elastic curves are ___

flatter/horizontal

Inelastic curves

steeper/vertical