Econ Test Chapter 5-6

What is Elasticity

How much do buyers and sellers react to a change in certain market conditions?

What Determines Price Elasticity of Demand?

Individual Prefrences

Availability of close substitutes

Necessities v. Luxuries

Definition of the market

Time Horizon

Price Elasticity of demand equation

% change in Q_d

 ____________

% change in P

What does it mean to be Elastic

Elasticity > 1

• Change in Price brings about greater change in Quantity Demanded 

i.e., 50% change in P causes > 50% change in Q_d

What does it mean to be Inelastic

Elasticity < 1

• Change in Price brings about lesser change in Quantity Demanded

• i.e., 50% change in P causes < 50% change in Q_d

What does it mean to be Unit Elastic

“Unit Elastic” = Elasticity = 1

• Change in Price brings about the same change in Quantity Demanded

i.e., 50% change in P causes 50% change in Q_d

How do we calculate the %-age changes and elasticity?

The Midpoint Method

What is the The Midpoint Method

Price Elasticity of Demand =

(Q₂-Q₁) / [(Q₂+Q₁)/2] → Midpoint

_____________________

(P₂-P₁) / [(P₂+P₁)/2] → Midpoint

General Rules of The Variety of Demand Curves

• The flatter the D curve that passes through a given point, the more elastic the Qd.

The steeper the D curve that passes through a given point, the less elastic the Qd.

What does it mean to be perfectly Inelastic

VERTICAL LINE

no matter change in price demand will not change

What does it mean to be perfectly elastic

HORIZONTAL LINE

Any change in price will effect the demand

Total Revenue equation

Total Revenue (TR) = P x Q

Total Revenue is the Good is elastic

• % change in Q_d > % change in P.

• If P rises → Q_d falls → TR falls

 The decrease in revenue from lower Q_d> increase in revenue from higher P

• If P falls → Q_d rises → TR rises

 (The increase in revenue from higher Q_d > decrease in revenue from lower P).

Total Revenue is the Good is inelastic

• % change in Q_d < % change in P.

• If P rises → Q_d falls → TR rises

  •  (The decrease in revenue from lower Q_d < the increase in revenue from higher P.)

• If P falls → Q_d rises → TR falls

  •  (The increase in revenue from higher Q_d < decrease in revenue from lower P. )

What is the Total Revenue if the Good is unit elastic

• E = ?:  % change in Q_d ? % change in P.

• If P rises → Q_d falls → TR ____?____.

  •  (The increase in revenue from higher P ___?___ the decrease in revenue from lower Q_d ).

• If P falls → Q_d rises → TR ____?____

 (The decrease in revenue from lower P ___?___ the increase in revenue from higher Q_d ).

What is Income Elasticity of Demand

How much Q_d responds to a change in consumers’ income.

% change in Q_d

_over

% change in income

What is the Cross-price Elasticity of Demand

Measure of how much Q_d of one good responds to a change in the price of another good.

% change in Q_d (Good 1)

over

% change in P (Good 2)

What is Price Elasticity of supply

A measure of how much the Q_s of a good responds to a change in the P of that good.

Loosely speaking, it measures sellers’ price sensitivity

What Determines Price Elasticity of Supply?

Flexibility of sellers and Time Horizon

Flexibility of sellers

The more/less easily the sellers can change the Q they produce.

Time Horizon

Short run = inelastic

Long run = elastic

The Variety of Supply Curves

• The flatter the S curve, the greater the P elasticity of S.

• The steeper the S curve, the lesser the P elasticity of S.

• Unit Elastic?

The Two Roles of Economists:

Scientist:

Develop and test theories

and

Policy Advisor:

Use the theories to better the world.

Price Controls

Price Ceilings and Price Floors

Price Ceilings

Places legal maximums on prices. Examples?

Price Floors

Places legal minimums on prices.

Why would the government enact a Price Ceiling or a Price Floor? 

To help buyers or sellers… when they think market prices are unfair to buyers or sellers.

Non-Binding Price Ceiling

—  P is set above equilibrium

Effect = no effect on P or Q

  Binding Price Ceiling

 P is set below equilibrium

Effect Shortage

Non-Binding Price Floor

P is set below equilibrium

No effect on P or Q

Binding Price Floor

—  P is set above equilibrium

—  Effect: a surplus!

What is the Purpose of taxes

• Raise revenue for public projects!

(Roads, schools, national defense, police, etc.)

Tax incidence

What portion of the tax burden is paid by whom (sellers or buyers)?

How do you find the Tax incidence

 By the market! (good ol’ Supply and Demand principles)

How do you find the Tax incidence steps

Step 1: Which curve is affected by the tax?

Step 2: In which direction does the curve shift?

Step 3: What effect does this have on equilibrium price and quantity?

Lessons about tax on sellers

• Taxes discourage market activity.

• Buyers and sellers share the burden of the tax (tax incidence)

Lessons about tax on buyers

• Taxes discourage market activity.

• Buyers and sellers share the burden of the tax.

Do Normal goods have postive or negtive elaticitie

postive

Do Inferior Goods have postive or negtive elaticitie

negtive

Necessitities have a small or large income elasticites

small

Luxuries have a small or large income elasticites

large

substitutes have postive or negtive cross price elasticities

positive

complements have postive or negtive cross price elasticities

negtive

Who carries the tax-incedent

whoever is the least inelastic

Who pays luxary tax

the wealthy

who is most effected by luxary tax

the middle class