Comprehensive Microeconomics Study Notes: Elasticity, Market Surplus, and Efficiency

Elasticity of Demand and Supply

  • Price Elasticity of Demand (PED):

    • Reflects the responsiveness of quantity demanded to changes in price.

    • Relatively Elastic Demand: Occurs when the percentage change in quantity demanded is greater than the percentage change in price (%ΔQd>%ΔP\% \Delta Q_d > \% \Delta P).

    • Unit Elastic Demand: Occurs when the price changes substantially, but total revenue does not change (Elasticity=1\text{Elasticity} = 1). Consumers still purchase the good because it is a necessity that people still need.

  • Cross-Price Elasticity of Demand:

    • Measures how the quantity demanded of one good responds to a change in the price of another good.

    • Complementary Goods:

      • Cross-price elasticity is less than zero (<0< 0), meaning it has a negative value.

      • Complementary goods work together in consumption.

      • Example: Hotdogs and hotdog buns. If the price of hotdogs goes up, fewer people buy hotdogs, causing hotdog bun sales to go down.

    • Substitute Goods:

      • Cross-price elasticity is greater than zero (>0> 0), meaning it has a positive value.

      • Substitute goods can replace one another in consumption.

      • Example: Subway and Quiznos are substitute goods.

  • Income Elasticity of Demand:

    • Measures how quantity demanded changes relative to changes in consumer income.

    • Normal Goods: A good is defined as a normal good if it has a positive income elasticity of demand.

  • Price Elasticity of Supply (PES):

    • Reflects the responsiveness of quantity supplied to a change in price (price moves first, which then causes quantity to move).

    • Formula:         PES=%ΔQs%ΔP\text{PES} = \frac{\% \Delta Q_s}{\% \Delta P}

    • Determinant of Elasticity: The supply curve remains more elastic when firms have more time in which they can respond to price changes.

    • Perfectly Elastic Supply: Graphically represented as a completely horizontal supply curve.

    • Perfectly Inelastic Supply: Has an elasticity value equal to 00

Market Efficiency and Surplus Dynamics

  • Consumer Surplus:

    • Defined graphically as the area below the demand curve and above the actual market price.

    • Increases in price are not welcomed by consumers because they directly cause a decrease in consumer surplus.

  • Producer Surplus and Seller Entry:

    • Defined graphically as the area above the supply curve and below the actual market price.

    • Seller Market Entry: More sellers enter the market when market prices are higher because the price exceeds the willingness to accept from a greater number of sellers.

  • Total Surplus:

    • Represents the total net benefits that everyone receives from a market.

    • Defined graphically as the area below the demand curve and above the supply curve.

    • Formula:         Total Surplus=Consumer Surplus+Producer Surplus+Tax Revenue\text{Total Surplus} = \text{Consumer Surplus} + \text{Producer Surplus} + \text{Tax Revenue}

  • Economic Efficiency:

    • Allocative Efficiency: Achieved by maximizing total surplus, ensuring that economic resources are being used to their fullest capacity to satisfy consumer preferences.

    • Productive Efficiency: Refers to producing goods at the lowest possible cost within the business world.

  • Government Intervention:

    • When the government intervenes in a market, it creates a deadweight loss, preventing market efficiency.

Profit Equation and Numerical Calculations

  • Profit Formula:     Profit=Revenue−Costs\text{Profit} = \text{Revenue} - \text{Costs}

  • Producer Surplus Calculation Example:

    • Scenario Baseline: A producer has a willingness to accept of $750\$750

    • Price Movement: Market price starts at $900\$900 and drops to $800\$800

    • Calculation of New Producer Surplus:         New Producer Surplus=New Price−Willingness to Accept\text{New Producer Surplus} = \text{New Price} - \text{Willingness to Accept}         New Producer Surplus=$800−$750=$50\text{New Producer Surplus} = \$800 - \$750 = \$50

    • (Note: The price drop of $100\$100 from $900\$900 to $800\$800 reduces the original surplus of $900−$750=$150\$900 - \$750 = \$150 down to a new surplus of $50\$50)