Microeconomics: Test 2 Note Guide2/4/14Elasticity of DemandElasticity 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) = η %∆QD/%∆Pp = Price elasticity of demandη%∆QD = percent change in quantity demanded%∆P = percent change in priceBy 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 quantityQn = new quantityQi = 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 pricePn = new pricePi = initial priceIf 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. a. p > 1ηb. %∆QD > %∆Pc. This means that consumers are relatively sensitive or responsive to price changes.2. The demand is inelastic if the value is less than one.a. p < 1ηb. %∆QD < %∆Pc. This means that consumers are insensitive to price changes.3. The demand is unit elastic if the value equals one.a. p = 1ηb. %∆QD = %∆Pc. This means that consumers are neither very responsive norunresponsive.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- Time1. Substitution effectsa. If there are good substitutes, then the elasticity will be longer.b. When there is a bad substitute or no substitute, it becomes inelastic.2. Income Effectsa. 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 ismore inelastic.3. Timea. The more time people have to adjust to a change, the more elastic itwill be.b. The less time to adjust, the less elastic it will be.i. Gas example: people will change habits to adjust in the longrun.Addiction & ElasticityNonusers’ demand for addictive substances is elastic.Users’ demand is inelastic. It only brings a small decrease in quantity demanded. Butit still changes it. 2/6/14Elasticity of Demand (continued)TR = TE = P x QD∆TR = ∆P + ∆QDTR – total revenueTE – total expenditureP – priceQD – 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)ηb. 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)ηb. 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 priceThe value will always be positive. It is interpreted the same way as price elasticity ofdemand.Cross-Elasticity of DemandCED = %∆QD/%∆PsCED – cross elasticity of demand%∆QD – percent change in quantity demanded%∆Ps – percent change in price of a substitute or complementIf 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 DemandIED = %∆QD/%∆IIED = 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.2/11/14Market EfficiencySpecial Interest Effect1. Most government regulation serves some special interest group.2. Charities and non-profit organizations can be special interest groups; often atthe 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 Market1. Market efficiency is measured by surplus in the market.a. Marginal benefit minus price equals consumer surplusi. MB – P = consumer surplusb. Producer surplus equals price minus marginal cost.i. P – MC = producer surplus2. Competitive Marketsa. 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 those that people valued more highly.c. 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
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