Efficiency, Market Disruptions, and Elasticity

Vocabulary flashcards covering economic efficiency types, consumer and producer surplus, market interventions (ceilings, floors, taxes, subsidies), deadweight loss, elasticity concepts, formulas, determinants, and total revenue relationships.

Economic Efficiency

The full employment of resources.

Productive Efficiency

Minimizing the costs of production.

Allocative Efficiency

Producing the most desirable mix of goods (the "right" amount of goods are produced at the "right" price, and buyers and sellers are satisfied).

Pareto Efficiency

A market solution that, once reached, cannot be improved upon: one participant cannot be made better off without making another less well off.

Consumer Surplus (CS)

The difference between the maximum amount that consumers are willing and able to pay for a good and the amount they actually pay for it; graphically represented as the area below the demand curve and above the current market price.

Producer Surplus (PS)

The difference between the amount that producers receive for a good and the minimum amount producers are willing and able to accept; graphically represented as the area above the supply curve and below the current market price.

Price Ceiling

A maximum legal price that may be charged for a good or service.

Price Floor

A minimum legal price that may be charged for a good or service.

Deadweight Loss

The decrease in consumer surplus and producer surplus that results from a market regulation.

Excise Tax

A per-unit tax paid by producers to the government, imposed either to change behavior or raise revenue. It shifts the supply curve up by the amount of the tax.

Subsidy

A per-unit payment to producers from the government, usually imposed to change behavior. It shifts the supply curve down by the amount of the subsidy.

Price Elasticity of Demand (Formula)

A measure of how much quantity demanded changes when product price changes, given by the formula: $e_d = \frac{\%\Delta Q_d}{\%\Delta P} = \frac{\left(\frac{Q_2 - Q_1}{Q_1}\right)}{\left(\frac{P_2 - P_1}{P_1}\right)}$

Price Elasticity of Supply

A measure of how much quantity supplied changes when the price of the product changes.

Income Elasticity of Demand

A measure of how much demand changes when consumer incomes change, expressed as: $\frac{\%\text{ change in } q \text{ demanded}}{\%\text{ change in income}}$

Cross-Price Elasticity of Demand

A measure of how much demand changes when the price of another good that could be consumed (complement or substitute) changes, expressed as: $\frac{\%\text{ change in } q \text{ demanded}}{\%\text{ change in price of complement or substitute}}$

Cross-Price Elasticity of Supply

A measure of how much supply changes when the price of another good that could be produced changes.

Relatively Elastic Demand ($E > 1$)

Demand where the numerator is greater than the denominator (percentage change in quantity is greater than percentage change in price). Quantity is responsive to changes in price; if price changes a little, quantity demanded changes more.

Relatively Inelastic Demand ($E < 1$)

Demand where the numerator is less than the denominator (percentage change in quantity is less than percentage change in price). Quantity is not very responsive to changes in price; if price changes a little, quantity demanded changes less.

Unitary Elastic Demand ($E = 1$)

Demand where the numerator and denominator are identical (percentage change in quantity and percentage change in price are the same). If price changes a little, quantity demanded changes by the exact same percentage.

Availability of Substitutes

A determinant of elasticity stating that, all other things equal, the more substitutes a good has, the more elastic the demand; the fewer substitutes, the more inelastic the demand.

Time Horizon (Determinant of Elasticity)

A determinant of elasticity stating that price elasticity is sensitive to time: over a longer period of time, demand for a product will be more elastic than in the short run.

Relative Price (Determinant of Elasticity)

A determinant of elasticity stating that if a product's price is high relative to consumer income (costing a significant part of the budget), demand will be relatively elastic, whereas inexpensive items tend to have more inelastic demand.

Price and Total Revenue Relationship (Inelastic Demand)

Price and total revenue move in the same direction: an increase in price causes total revenue to increase, and a decrease in price causes total revenue to decrease.

Price and Total Revenue Relationship (Elastic Demand)

Price and total revenue move in opposite directions: an increase in price causes total revenue to decrease, and a decrease in price causes total revenue to increase.

Price and Total Revenue Relationship (Unitary Elasticity)

Neither an increase in price nor a decrease in price leads to a change in total revenue (total revenue experiences no change).

Price Ceiling in the Gasoline Market

A regulation setting a maximum legal price ($P_c = \$3.25$) below the equilibrium price ($\$3.75$), which restricts quantity supplied to $Q_1$, creates a shortage between $Q_1$ and $Q_2$, and results in deadweight loss.

Price Floor in the Gasoline Market

A regulation setting a minimum legal price ($P_f = \$4.00$) above the equilibrium price ($\$3.75$), reducing quantity demanded to $Q_1$, generating a surplus from $Q_1$ to $Q_2$, and creating deadweight loss.