1Professor C.L. BallardFall Semester, 2012 ECONOMICS 201 KEY CONCEPTS FROM THE MIDDLE PART OF THE COURSEI. ElasticityA. The own-price elasticity of demand is our measure of the responsiveness of quantity demanded for a good to changes in the current price of the good. An analogous measure is used for the elasticity of supply. The own-price elasticity of demand is defined as the proportionate change in quantity demanded, divided by the proportionate change in price. We get the same results if we define the own-price elasticity of demand as the percentage change in quantity demanded, divided by the percentage change in price. In this course, our convention is to drop the minus sign, so that the demand elasticity is positive when the Law of Demand is obeyed. Another convention is to use the average, or midpoint, of the beginning and ending prices as our measure of the reference level of price, and to use the average or midpoint quantity demanded as our measure of the reference level of quantity demanded.B. A vertical demand curve is perfectly inelastic, and has elasticity of zero. A horizontal demand curve is perfectly elastic, and has elasticity of infinity. Along a downward-sloping, straight-line demand curve, the elasticity decreases as we go down from left to right.C. In an elastic portion of a demand curve, the elasticity exceeds one. Total revenue for the sellers of a good is equal to the price received by the sellers, multiplied by quantity: TR = (P)(Q). If demand is elastic, total revenue for the sellers will grow as price falls. This is because, when the price falls and demand is elastic, the increase in quantity demanded is sufficiently large that it will outweigh the price decrease. Similarly, if demand is elastic, total revenue will fall when price rises. D. In an inelastic portion of a demand curve, the elasticity is less than one. If demand is inelastic, total revenue for the sellers will fall as price falls. This is because, when the price falls and demand is inelastic, the increase in quantity demanded is relatively small, and is not large enough to outweigh the price decrease. Similarly, if demand is inelastic, total revenue will increase when price increases. E. When demand is unit elastic, the elasticity is exactly one, and sales revenue will not change when price changes. This is because, when the elasticity is one, the percentage change in price is exactly equal to the percentage change in quantity demanded. Thus, any change in price is exactly offset by a change in quantity demanded, and the total revenue will remain unchanged.F. All else equal, demand tends to be more elastic (i.e., the own-price elasticity of demand tends to be larger) if it is easy to substitute away from a good when its price changes. Also, all else equal, demand tends to be more elastic if consumers are given a longer period of time in which to adjust to changes in price. Finally, all else equal, demand tends to be more elastic if the item is a relatively large share of the consumer’s expenditure.2G. The income elasticity of demand measures the responsiveness of demand to changes in the incomes of buyers. Whereas the own-price elasticity of demand refers to movements along an existing demand curve, the income elasticity of demand refers to shifts in the demand curve caused by changes in income. The income elasticity is the percentage change in demand, divided by the percentage change in income. The income elasticity is positive for normal goods and negative for inferior goods.H. The cross-price elasticity of demand measures the responsiveness of demand for one good to changes in the price of some other good. Whereas the own-price elasticity of demand refers to movements along an existing demand curve, the cross-price elasticity of demand refers to shifts in the demand curve caused by changes in the prices of other goods. The cross-price elasticity is the percentage change in demand for one good, divided by the percentage change in the price of another good. The cross-price elasticity is negative for complements and positive for substitutes. When the cross-price elasticity of demand is zero, we say that the two goods are “independent in demand”.I. The (own-price) elasticity of supply is the percentage change in quantity supplied, divided by the percentage change in the price. When the Law of Supply is obeyed, the supply elasticity will be a positive number. However, the Law of Supply is not always obeyed. In the case of something that cannot be reproduced (e.g., Leonardo’s painting “Mona Lisa”), the supply curve is vertical. In this case, the supply elasticity is zero, and we say that supply is perfectly inelastic. If the supply curve is horizontal, supply is perfect elastic. For many goods, the supply elasticity will be larger when sellers are given a longer time period over which to adjust their behavior. In other words, as we give suppliers more time to adjust, they may be able to respond more to a change in price.II. Consumer BehaviorA. Total utility is the maximum amount that a consumer is willing to pay for a particular quantity of some item. Marginal utility is the extra amount of money that the individual is willing to pay, in order to consume one additional unit. Thus marginal utility is the change in total utility, when quantity increases by one unit. We assume that consumers have diminishing marginal utility, which means that their marginal utility will decrease when the quantity of their consumption of a good increases.B. For now, we assume that the individual consumer is too small to affect the market price. Therefore, the individual consumer takes the market price as given. (Later in the course, we will consider the case in which buyers have some ability to manipulate the price to their advantage.) The consumer will maximize satisfaction by choosing the quantity at which marginal utility is equal to price for every commodity. In this case, the individual demand curve is given by the marginal utility curve. C. Total expenditure is the total amount that buyers pay for a particular quantity of some item. Total expenditure is equal to the price paid by the buyers, multiplied by the quantity: TE = (P)(Q). If there are no taxes, the buyers’ price will be the same as the sellers’ price, so that total revenue for the sellers is equal to total3expenditure by the buyers. If there are taxes, total expenditure by the