Chapter 5 Mankiw Quiz Flashcards
Price Elasticity of Demand and Income Elasticity of Demand
- The price elasticity of demand measures how much the quantity demanded responds to a change in price.
- The income elasticity of demand measures how much the quantity demanded responds to changes in consumers' income.
Determinants of Price Elasticity of Demand
- Availability of close substitutes: Goods with close substitutes have greater price elasticities.
- Necessity vs. luxury: Necessities have lower price elasticities than luxuries.
- Breadth of market definition: More narrowly defined markets have greater elasticities.
- Time horizon: The elasticity of demand is greater over a longer time horizon.
Elastic vs. Inelastic Demand
- If elasticity > 1, demand is elastic.
- Percentage change in quantity demanded exceeds the percentage change in price.
- If elasticity = 0, demand is perfectly inelastic.
- No change in quantity demanded when there is a change in price.
Impact of Price Change on Total Revenue
- If demand is elastic, an increase in price reduces total revenue.
- Quantity demanded falls by a greater percentage than the price rises.
- Total revenue moves in the opposite direction as the price.
Inferior Goods
- A good with an income elasticity less than zero is called an inferior good.
- As income rises, the quantity demanded declines.
Price Elasticity of Supply
- Calculated as the percentage change in quantity supplied divided by the percentage change in price.
- Measures how much quantity supplied responds to a change in price.
Price Elasticity of Supply with Fixed Quantity
- If a fixed quantity of a good is available, and no more can be made, the price elasticity of supply is zero.
- Regardless of the percentage change in price, there will be no change in the quantity supplied.
Impact of Crop Destruction on Farmers
- Destruction of half of a fava bean crop is more likely to hurt fava bean farmers if the demand for fava beans is very elastic.
- The supply curve shifts to the left, resulting in a higher price.
- With elastic demand, an increase in price leads to a decrease in total revenue because the decrease in quantity demanded outweighs the increase in price.
Elasticity Examples
Required Textbooks vs. Mystery Novels
- Mystery novels have more elastic demand because they have close substitutes, while required textbooks are a necessity.
Adele Recordings vs. Pop Music Recordings
- Adele recordings have more elastic demand because they are a narrower market with many substitutes.
Subway Rides
- Subway rides during the next five years have more elastic demand because, over a longer time period, people have more time to adjust their behavior.
Root Beer vs. Water
- Root beer has more elastic demand because it is a non-essential, and there are more substitutes.
Airline Tickets Demand
Price Elasticity of Demand Calculation
- Business Travelers: Inelastic demand
- Vacationers: Elastic Demand
Reasons for Different Elasticities
- Vacationers have elastic demand because they are more flexible, price-sensitive, and have substitutes.
- Business travelers have inelastic demand because they are less flexible, often not paying out of pocket, and have fewer alternatives.
Calculation Example
- Price rises from $200 to $250.
- Vacationers:
(800+600)/2(600−800)/(200+250)/2(250−200)=700−200/22550=−0.2857/0.2222=−1.29
Heating Oil Demand
Short Run vs. Long Run Elasticity
- Price elasticity of demand for heating oil:
- Short run: 0.2
- Long run: 0.7
Impact of Price Increase
- Price of heating oil rises from $1.80 to $2.20 per gallon.
- Percentage change in price: (2.20+1.80)/22.20−1.80×100=2.000.40×100=20%.
- Short run:
Percentage change in quantity=0.2×(−20%)=−4% - Long run:
Percentage change in quantity=0.7×(−20%)=−14%
Time Horizon
- Elasticity depends on the time horizon because people have more options and flexibility in the long run.
- Short Run – People can't change much right away, homes are already built and heating systems already installed, switching fuels or improving takes time and money Fewer options = inelastic demand
- Long Run - People have time to adapt, insulate their homes better, buy more efficient heaters, switch to alternative energy source More options more elastic demand
Elasticity and Total Revenue
- A price change causes the quantity demanded of a good to decrease by 30 percent, while the total revenue of that good increases by 15 percent.
- Demand is inelastic because the total revenue increased despite a large drop in quantity demand.
Complements and Inelastic Demand
Coffee and Donuts
- Cups of coffee and donuts are complements. Both have inelastic demand.
- A hurricane destroys half the coffee bean crop.
Price of Coffee Beans
- Increases: The destruction of half the coffee bean crop drastically reduces the supply of coffee beans. Since demand for coffee beans is inelastic, even with a higher price, consumers will still purchase a large portion of the available beans. This leads to a substantial increase in the price of coffee beans.
Price and Total Expenditure on Cups of Coffee
- The price increases because coffee becomes more costly to produce. This is shown by a leftward shift in the supply curve. Since the demand for coffee is inelastic, people don't cut back much.
Price and Total Expenditure on Donuts
- The Demand for donuts shifts to the left; donuts have inelastic demand, so even though quantity falls, it doesn't fall a lot.
Price of Aspirin
- The price of aspirin rose sharply last month, while the quantity sold remained the same.
Possible Diagnoses
- Meredith: Demand increased, but supply was perfectly inelastic.
- Alex: Demanded increased, but it was perfectly inelastic
- Miranda: Demand increased, but supply decreased at the same time
- Richard: Supply decreased, but demand was unit elastic.
- Owen: Supply decreased, but demand was perfectly inelastic
Correct Explanations
- Meredith and Owen could possibly be right.
Demand Schedule for Pizza