econ exam 2

consumer surplus

the difference between what consumers (as individuals or the market) would be willing to pay and the
market price.

• the area beneath the demand curve and above the price

willingness to pay for good

is the maximum price at which he or she would buy that good.

total consumer surplus

is the entire shaded area—the sum of the individual consumer surpluses

consumer surplus equation

willingness to pay - market price

producer surplus

market price - price at firms are willing to pay

when does consumer surplus rise

with a fall in price

producer surplus

the difference between market price and the price at which firms are willing to supply the product.

total producer surplus

from sales of a good at a given price is the area above the supply curve but below that price

producer surplus rises

if the price increases

total surplus

is maximized at market equilibrium

• is the sum of the producers and consumers surpluses

price controls

legal restrictions on market prices

price ceiling

a maximum price sellers are allowed to charge for a good or service (usually set BELOW equilibrium)

price floor

a minimum price buyers are required to pay for a good or service (usually set ABOVE equilibrium)

how price ceilings cause inefficeincy

• Inefficiently low quantity
   Inefficient allocation to customers
   Wasted resources
   Inefficiently low quality
   Black markets

dead weight loss

the loss in total surplus that occurs whenever an action or a policy reduces the quantity transacted below the efficient market equilibrium quantity

non binding price floor

price floor is set below equilibrium, it will have no effect

binding or effective price floor

price floor that forces price above equilibrium will have any effect

quota

an upper limit, set by the government, on the quantity of some good that can be bought or sold; also referred to as a quantity control.

• quotas impose loss on society

elastic

when an increase in price reduces the quantity demanded a lot

when a decrease in price increases the quantity demanded a lot

inelastic

increase in price reduces quantity demanded a little

decrease in price reduces quantity demanded a little

price elasticty of demand

The more responsive quantity demanded is to a change in price, the more elastic is the demand curve

price elasticity of demand equation

price of elasticity demanded = % change in quantity demanded / % change in price

percent change

% change = change in amount / initial amount

% change = new - old / old

point elasticity

E = (New - Old)Q over old Q / (New - Old)P over old P

midpoint elasticity

E= (New-old)Q over average Q / (New - old)P over average P OR

E= (New - old) Q over (Old+new)Q/2 / (New - Old) P over (Old + new)P/2

inelastic

If the |Ed| < 1, demand curve is inelastic

• slight downward sloping

perfectly inelastic

If the |Ed| =0, demand curve is perfectly inelastic

• vertical line on the graph

elastic

If the |Ed| > 1, demand curve is elastic

• more curved than inelastic but still downward sloping

perfectly elastic

If the |Ed| =∞, demand curve is perfectly elastic.

• horizonatal line on the graph

unit elastic

If the |Ed| = 1, demand curve is unit elastic

• moderate downward slope facing outward

total revenue

TR = P x Q

demand inelastic

When demand is inelastic, the price effect dominates the quantity effect

• TR = P x Q

demand elastic

the quantity effect dominates the price effect

• TR = P x Q

unit elastic

the quantity effect equals the price effect

availibillity of close substitutes

if there are many substitutes its elastic

if there are few substitutes its inelsatic

Whether the good is a necessity or a luxury also affects the elasticity of demand.

For necessities, we do not change Q much when P changes —> inelastic

For luxuries, we are more sensitive to P changes —> elastic

The length of time elapsed since the price change matters

Less time to adjust means lower elasticity

Over time consumers can adjust their behavior by finding substitutes (making demand more elastic)

cross-price elasticity of demand

measures how sensitive the quantity demanded of good A is to the price of good B

cross price elasticity of demand equation

%change in quantity demanded of A / % change in price of B

for substitutes cross-price elasticity

positive

for compliments cross-price elasticity

negative

income elasticity of demand

measures how sensitive the quantity demanded of a good is to changes in income.

Income elasticity of demand

% change in quantity demanded / % change in income

income elasticity of normal good

positive

income elasticity of inferior good

negative

income elastic goods

income elasticity is > 1

income inelastic goods

income elasticity is < 1 but positive

price elasticity of supply

% change in quantity supplied / % change in price

price elasticity of supply effect - availibillity of inputs

If increased production is very expensive, then the supply curve will be inelastic

If production can be increased cheaply, then the supply curve will be elastic

price elasticity of supply effect - Time

Price elasticity of supply increases as producers have more time to respond to price changes.

• More time more elastic

what is an incidence of tax

a measure of who really pays it.

when the burden of excise tax is mostly in consumers

When the price elasticity of demand is low and the price elasticity of supply is high,

when the burden of excise tax is mostly on producers

When the price elasticity of demand is high and the price elasticity of supply is low

goal of tax

the goal of taxing is to minimize dead weight loss

the benifits principle

Those who benefit from public spending should bear the burden of the tax that pays for that spending

the-ability-to-pay principle

Those with greater ability to pay a tax should pay more tax