MicroEconomics Chapter 5-7

Elasticity

is a measure of how much buyers and sellers respond to changes in market conditions.

price elasticity of demand

measures how much the quantity demanded responds to a change in the price

Demand for a good is said to be elastic

if the quantity demanded responds substantially to price changes.

Demand is said to be inelastic

if the quantity demanded responds only slightly to price changes.

Goods with close substitutes

tend to have more elastic demand because it is easier for consumers to switch from those goods to others.

For a true necessity

a small price increase won’t diminish the amount you purchase by very much: Another way of saying this is that necessities tend to have inelastic demands.

Narrowly defined markets

tend to have more elastic demand than broadly defined ones

Demand tends to be more elastic

over longer periods of time.

a larger price elasticity implies

a greater responsiveness of quantity demanded to price changes.

When the quantity moves proportionately more than the price

, the elasticity is greater than one, and demand is said to be elastic.

When the quantity moves proportionately less than the price

the elasticity is less than one, and demand is said to be inelastic.

when the percentage change in quantity equals the percentage change in price

the elasticity is exactly 1, and demand is said to have unit elasticity.

The flatter the demand curve at a given point

the greater the price elasticity of demand.

The steeper the demand curve at a given point

the smaller the price elasticity of demand.

In the extreme case of zero elasticity

demand is perfectly inelastic, and the demand curve is vertical. In this case, regardless of the price, the quantity demanded stays the same.

demand is perfectly elastic

This occurs as the price elasticity of demand becomes so large that it approaches infinity. The demand curve becomes horizontal, showing that tiny changes in the price lead to huge changes in the quantity demanded.

total revenue

the amount paid by buyers and received by sellers of the good

when demand is inelastic (a price elasticity less than one

the price and total revenue move in the same direction: If the price increases, total revenue also increases.

When demand is elastic (a price elasticity greater than one

the price and total revenue move in opposite directions: If the price increases, total revenue decreases.

If demand is unit elastic (a price elasticity exactly equal to 1

total revenue stays the same when the price changes.

At points with a low price and high quantity

a linear demand curve is inelastic

At points with a high price and low quantity

a linear demand curve is elastic.

A linear demand curve never

has a constant elasticity.

The income elasticity of demand

demand measures how the quantity demanded changes as consumer income changes. It is calculated as the percentage change in quantity demanded divided by the percentage change in income. 

The cross-price elasticity of demand

measures how the quantity demanded of one good responds to a change in the price of another. It is calculated as the percentage change in the quantity demanded of good one divided by the percentage change in the price of good two.

The price elasticity of supply

measures how much the quantity supplied responds to changes in the price.

Supply is said to be elastic

if the quantity supplied responds substantially to price changes

Supply is said to be inelastic

if the quantity supplied responds only slightly.

in the long run

the quantity supplied responds substantially to price changes.

In the extreme case of zero elasticity

supply is perfectly inelastic, and the supply curve is vertical. In this case, the quantity supplied is the same regardless of the price.

supply is perfectly elastic

This occurs as the price elasticity of supply approaches infinity and the supply curve becomes horizontal, meaning that tiny price changes lead to large changes in the quantity supplied.

Because the price is not allowed to rise above this level

the legislated maximum is called a price ceiling

Because the price cannot fall below this level

the legislated minimum is called a price floor .

the price ceiling is not binding

because the price that balances supply and demand ($3) is below the ceiling. Market forces move the economy to the equilibrium, and the ceiling does not affect the price or the quantity sold.

the ceiling is a binding constraint on the market

Because the equilibrium price of $3 is above the price ceiling. The forces of supply and demand tend to move the price toward equilibrium, but the ceiling prevents the market price from reaching it( creates shortage).

When the government imposes a binding price ceiling on a competitive market

a shortage arises, and sellers must ration scarce goods among potential buyers.

A binding price floor causes

a surplus.

TAX ON SELLER;CBecause the tax is not imposed on buyers

the quantity demanded at any price remains the same; thus, the demand curve does not change. 

TAX ON SELLER: Because the tax on sellers raises the cost of producing and selling ice cream

it reduces the quantity supplied at every price. The supply curve shifts to the left (or, equivalently, upward).

TAX ON SELLERS:When a good is taxed

the quantity sold is smaller in the new equilibrium. Taxes discourage market activity

TAX ON SELLERS: Buyers and sellers share

the tax burden. In the new equilibrium, buyers pay more, and sellers receive less.

TAX ON BUYERS:The immediate impact is on the demand for ice cream

The supply curve doesn’t change because, for any price, sellers have the same incentive to provide ice cream to the market. But buyers now must pay a tax to the government (on top of the price to the sellers), so the tax shifts the demand curve for ice cream.

TAX ON BUYERS:Because the tax makes buying ice cream less attractive

buyers demand a smaller quantity of ice cream at every price. The demand curve shifts to the left (or, equivalently, downward),

TAX ON BUYERS: Sellers get a lower price for their product

buyers pay a lower market price to sellers than they previously did, 

Taxes on sellers and taxes on buyers are

equivalent.

A tax burden falls more heavily on the side of the market that is

less elastic

welfare economics

the study of how the allocation of resources affects economic well-being.

A buyer’s maximum is called her

willingness to pay , and it measures how much she values the good. Each buyer would be eager to buy the album at a price less than her willingness to pay,

Consumer surplus is

the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.

At any quantity, the price given by the demand curve shows the willingness to pay of the marginal buyer

the buyer who would leave the market first if the price were any higher

The area below the demand curve and above the price measures

the consumer surplus in a market.

consumer surplus measures

the benefit that buyers derive from a market as the buyers themselves perceive it

Producer surplus is

the amount a seller is paid minus his cost of production. It measures how much a seller benefits from participating in a market.

marginal seller

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

The area below the price and above the supply curve measures

the producer surplus in a market. 

Consumer surplus is the benefit that buyers receive from participating in a market, and producer surplus is the benefit that sellers receive. Total surplus is, therefore

a natural variable for the social planners to consider when judging a market’s allocation of resources.

Competitive markets allocate the supply of goods to

the buyers who value them most, as measured by their willingness to pay.

Competitive markets allocate the demand for goods to

the sellers who can produce them at the lowest cost.

Competitive markets produce the quantity of goods that

maximizes the sum of consumer surplus and producer surplus.