Final Exam Study GuideChapter 5: Elasticity and its Applications Define: - Elasticity: numerical measure of responsiveness of quantity demanded or quantity supplied to one of its determinants. - Elasticity of demand: o Elastic: When an increase in price reduces quantity demanded a LOT (flatter curve).o Inelastic: When the same increase in price reduces quantity demanded by a little.  The more responsive quantity demanded is to a change in price, the more elastic the demand curve is. - Determinants of a shift in the demand curve:o Availability of substitutes: fewer substitutes means more inelastic and vice versa. o Time horizon: less time to adjust equals less elasticity in the short runo Category of product (narrow vs. broad): the less specific means the more inelastic Ex. Elasticity is higher for “lettuce” (specific) than “food” (broad)o Necessities vs. luxuries: necessities are inelastic and luxuries are elastico Purchase size: the difference between buying a car vs. candy if the price were to riseLess elastic More elasticFewer substitutes More substitutesShort run (less time) Long run (more time)Necessities LuxuriesSmall part of budget Large part of budget- Ed<1=inelastic- Ed>1=elastic- Ed=1 unit elastic - Ed=percent change in quantity demanded/percent change in price ECON 1 1st Edition- Midpoint method: end-initial/(end+initial)/2o 1st use the midpoint formula to find percent change in priceo 2nd find percent change in Qdo Then use the elasticity of demand formula- The slope of a linear demand curve is constant but its elasticity is not. - Revenue= P x Q- Price increase equals more revenue but lower quantity because of the law of demando The fall in revenue from lower Q is greater than increase in revenue from higher price so revenue falls.  When demand is elastic, an increase in price causes revenue to fallo The fall in revenue from lower quantity is smaller than increase in revenue from higher price so revenue rises. When demand is inelastic, a price increase causes revenue to rise.Elasticity Name Price and RevenueEd<1 Inelastic P and R move togetherEd>1 Elastic P and R move oppositeEd=1 Unit elastic P chances but everythingelse stays the sameElasticity of supply:- When price increases, quantity supplied increases as well and by a LOT. - When price increases, quantity supplied increases by a little. Determinants: - Change in per-unit costs with increased production:o Increased production expensive? Inelastic. o Increased production not expensive? Elastic.- Time horizon matters:o Short run= inelastic and long run=elastic- Share of market for inputs used in production matterso Supply elastic when industry can be expanded without causing a big increase in demando Inelastic when expansion causes significant increase in demand - Geographical scope of market matterso Wider scope (global) is less elastico Narrower (local) is more elasticLess elastic More elasticDifficult to increase Easy to increaseRaw materials Manufacturing goodsShort runs Long runLarge share Small shareGlobal LocalThe equations for the elasticity of supply are the same as the ones for elasticity of demand, just change Qd to Qs. Chapter 6: Taxes and SubsidiesCommodity Taxes: - Who pays tax does not depend on who writes the check- Who pays does depend on elasticities- Commodity taxes raise revenue and create deadweight loss from trade- Taxes=surplus!Tax on sellers:- Buyers pay more than before and sellers receive less than before- The supply curve shifts up by however much the tax was. *The less elastic pays the greater share of the tax, more burden- Elasticity equals escape! Effects of tax: Generates revenue and creates deadweight lossSubsidies: - Reverse tax where government gives money to consumers or producers o P received by sellers – price paid by buyers- Who benefits depends on elasticities- Paid for by taxpayers and creates deadweight loss- Wage subsidies increase employment- The tax on sellers is equivalent to the tax on buyersQ: If the demand of some good is more elastic than supply and the tax is imposed on the consumption of the good, who bears more of the burden of the tax?A: Producers do because consumers have a greater ability to change their behavior in response to the tax.Chapter 7: Price System- The teacher assistants said the only thing we needed to know about this chapter is:o How markets link the world Ex. flower marketo Speculation is the attempt to profit from future price changes  Smooth price over time and improve welfareChapter 8: Price Floors and CeilingsPrice controls: 1. Price ceilings: makes it illegal for prices to move above a maximum price2. Price floors: below minimum priceA. Price ceilings create shortages.a. The price legally charged is below the market price (equilibrium price)i. Price cannot go higher than the ceiling priceb. Effects:i. Shortages: Qd>Qs, the lower the controlled price, the larger the shortage1. Sellers have more customers than goodsii. Reduction on quality1. Sellers cannot raise the price or else they break the law so the cut qualitya. Ex. service quality at the gas station is gone!iii. Wasteful lines and search costsiv. Lost gains from trade1. Deadweight loss: total cost consumer and producer surplus when not all mutually profitable gains from trade are exploitedv. Misallocation of resources1. Ideal: allocate quantity of oil supplied to its highest valued uses but those potential consumers are legally prevented from signaling their higher value by offering to pay oil suppliers more than the controlled pricea. Most users have lower-value usesB. Price Floors:a. When the minimum price that can be legally charged is above the market price. Prices cannot legally go below the floor Ex. labor and control of minimum wageb. Effects:i. Surpluses:1. Surplus of labor equals unemployment 2. Minimum wage decreases employment among low-skilled workers3. Reduces gains from trade; created deadweight lossii. Lost gains from trade:1. Employers would hire more workers if they could offer lower wagesiii. Wasteful increases in quality 1. Price floors cause firms to compete by offering customers higher quality2. Increase in quality that consumers are not willing to pay for is wasteful increase in qualityiv. Misallocation of resourcesChapter 9: International TradeThree benefits of trade: 1. Division of knowledgea. Specialization followed by trade increases productivityi. Ex. doctors=neurologists, dentists, cardiologists2. Economies of