econ 1 midterm 2

elasticity of demand 

percentage change in quantity demanded/percentage change in price 

inelastic demand

elasticity is less than 1

unit elastic

elasticity = 1

elasticity rule

if two linear demand or supply curves run through a common point, the curve that is flatter is more elastic

determinants of demand elasticity

availability of substitutes, time horizon, category of product (narrow vs broad), necessities vs luxuries, purchase size (relative to our budget)

elastic demand

elasticity is greater than 1

revenue

price x quantity demanded

price increase effect on revenue 

more revenue per unit sold, but fewer units are sold 

revenue falls when price increases

when demand is elastic (change in Qd is greater than change in price)

revenue increases when price increases

when demand is inelastic

determinants of elasticity of supply

change in per unit costs with increased production, time horizon, the share of the market for the inputs used in production (can the industry expand without significant increase in demand and price of inputs), geographic scope

flatter cuve

more elasticity

income elasticity of demand

percent change in quantity demanded/percent change in income

normal goods

income elasticity is positive

luxury goods

income elasticity is greater than 1

inferior goods

income elasticity is negative

cross price elasticity of demand

measures the response in demand for one good to changes in the price of another good (percent change in Qd for good 1/percent change in Qd for good 2

substitutes

cross price elasticity is postivie (greater than 0)

complements

cross price elasticity is less than 0 (negative)

price controls 

price ceilings and floors 

price ceiling

a legal maximum on the price of a good or service

binding

a price ceiling below equilibrium or a price floor above equilibrium

effects of price ceiling on market outcome

shortage, reduction in product quality, wasteful lines and other costs of search (bribery), loss of gains from trade (caused by shortage), misallocation of resources

total price of a good (with price control)

legal price + time cost (higher than controlled price)

price floor

legal minimum on the price of a good or service 

effects of a price floor above equilibrium price

lost gains from trade, wasteful increase in quality, misallocation of resources

commodity tax

tax on goods —> raises revenue but creates lost gains from trade

incidence of a tax

how the burden of a tax is shared among market participants 

if supply is more elastic than demand

buyers bear most of the burden of the tax because it is easier for sellers than buyers to leave the market

if demand is more elastic than supply

sellers bear the burden of the tax because it is easier for sellers than buyers to leave the market

subsidy

reverse tax, gov gives money to consumers or producers (price recieved by sellers - price paid by buyers)

welfare economics

studies how the allocation of resources affects economic well being

allocation of resources

how much of each good is produced, which producers produce it, which consumers consume it

willingness to pay

the max amount a buyer will pay for a good —> at any Q, the height of the demand curve 

consumer surplus

the amount a buyer is willing to pay minus the amount the buyer actually pays

total consumer surplus

the area under the demand curve above the price from 0-Q (1/2 base x height)

if price rises

consumer surplus reduces because buyers leave the market and the remaining buyers pay higher prices

cost

everything a seller must give up to produce a good (including time) —> measures willingness to sell (at any Q, the height of the supply curve)

producer surplus 

the amount a seller is paid for a good minus the sellers cost 

total producer surplus

the area above the supply curve under the price (from 0-Q)

if price reduces

producer surplus decreases due to sellers leaving the market and remaining sellers getting a lower price for their goods

total surplus

value to buyers - cost to sellers (used as a measure of well being/efficiency 

efficient allocation of resources

maximizes total surplus

markers of efficiency

goods are consumed by buyers that value them most, goods are produced by producers with the lower costs, raising or lowering the quantity of a good would not increase total surplus

market equilibrium

maximizes total surplus