Microeconomics Test 2 Note Guide Elasticity of Demand 2 4 14 Elasticity of demand allows you to compare the changes in demand when the units are measured difficulty Ex dollars per gallon and Euros per liter Price elasticity of demand Pure number no units QD P p Price elasticity of demand QD percent change in quantity demanded P percent change in price By making the values in to percentages you effectively get rid of units leaving you with a number that can be used for comparisons Algebraically the value will be negative but the changes are always opposite The value is always absolute value to get a positive number Midpoint Midpoint method helps standardize the price elasticity of demand When percent change in price or percent change in quantity demanded isn t given you can use the mid point method to determine it Q Qn Qi Qn Qi 2 x100 Q percent change in quantity Qn new quantity Qi initial quantity If you don t know the percentage change in quantity demanded use the midpoint method to calculate it as a percent of the average of the new quantity and initial quantity P Pn Pi Pn Pi 2 x100 P percent change in price Pn new price Pi initial price If you don t know the percentage change in price use the midpoint method Now that you have the percentage change in quantity and price you can find price elasticity of demand What does the number mean 1 The demand is elastic if the value is greater than one p 1 a b QD P c This means that consumers are relatively sensitive or responsive to price changes 2 The demand is inelastic if the value is less than one p 1 a b QD P c This means that consumers are insensitive to price changes 3 The demand is unit elastic if the value equals one p 1 a b QD P c This means that consumers are neither very responsive nor unresponsive 4 Perfectly Inelastic a A PID curve is vertical b When the price rises the quantity demanded doesn t change c Value is zero 5 Perfectly Elastic a A PED curve is horizontal b People are extremely responsive to change c Value is close to infinity What causes elasticity Substitution effects Income Effects Time 1 Substitution effects If there are good substitutes then the elasticity will be longer a b When there is a bad substitute or no substitute it becomes inelastic 2 Income Effects a If it s a large part of a person s income then it will be more elastic b When it s a smaller part of the income there is a smaller effect and is more inelastic a The more time people have to adjust to a change the more elastic it b The less time to adjust the less elastic it will be i Gas example people will change habits to adjust in the long 3 Time will be run Addiction Elasticity Nonusers demand for addictive substances is elastic Users demand is inelastic It only brings a small decrease in quantity demanded But it still changes it Elasticity of Demand continued 2 6 14 TR TE P x QD TR P QD TR total revenue TE total expenditure P price QD quantity demand change in When prices go down more units will be sold P decreases QD increases 1 The demand is elastic if a QD P 1 b Percent change in quantity demanded is greater than percent change in price c As a result i When prices drop quantity demanded goes up which makes total revenue go up P decrease QD increases and TR increases ii When prices rise quantity demanded goes down which makes total revenue go down P increases QD decreases and TR decreases 2 The demand is inelastic if a QD P 1 b Percent change in quantity demanded is less than percent change in price c As a result i When prices drop quantity demanded goes up but total revenue drops P decreases QD increases but TR decreases ii When prices rise quantity demanded falls and total revenue rises P increases QD decreases TR increases Elasticity of Supply PES QS P PES price elasticity of supply QS percent change in quantity supplied P percent change in price The value will always be positive It is interpreted the same way as price elasticity of demand Cross Elasticity of Demand CED QD Ps CED cross elasticity of demand QD percent change in quantity demanded Ps percent change in price of a substitute or complement If the coefficient is zero the two goods are unrelated goods The cross price elasticity of demand between substitutes is positive The cross price elasticity of demand between complements is negative Before you could drop the sign of the coefficient because it didn t tell you any information You can t drop the sign now because it gives us information to whether a good is a substitute or complement Income Elasticity of Demand IED QD I IED Income elasticity of demand QD percent change in quantity demanded I percent change in income When the coefficient is positive that means the good is a normal superior good When the coefficient is negative that means the good is an inferior good Market Efficiency Special Interest Effect 2 11 14 1 Most government regulation serves some special interest group 2 Charities and non profit organizations can be special interest groups often at the expense of the general public and more specifically taxpayers 3 Most special interest groups say they benefit the public 4 Trade groups business lobbies consumer advocacy and public interest groups often go to great lengths to prevent you the public from finding out who pays their bills because in truth they re just promoting some special interest agenda Efficiency in Market 1 Market efficiency is measured by surplus in the market a Marginal benefit minus price equals consumer surplus i MB P consumer surplus b Producer surplus equals price minus marginal cost i P MC producer surplus 2 Competitive Markets a The economically efficient amount in a market is when marginal benefit equals marginal cost b A situation in which the quantities of goods or services produced are c those that people valued more highly In a competitive market the demand curve shows consumers marginal benefit and the supply curve shows suppliers marginal cost Therefore the point at which the supply curve and demand curve meet is the equilibrium price d The net gain to consumers and producers together at this point is greater than at any other quantity e The invisible hand pushes buyers and sellers to go to the equilibrium i People have an incentive to produce goods that others want ii People don t produce things for consumers so the consumers can have the goods Producers do it to make money they are driven by self interest f Prices provide incentives for sellers to supply the efficient quantity of each good
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