MICROECONOMICS QUIZ 2 Chapters 5 7 Chapter 5 Elasticity Elasticity measures how much one variable responds to change in another numerical measure of responsiveness of quantity demanded or supplied in terms of determinant Price elasticity of demand change in Qd change in price how much quantity demanded responds to a change in price price sensitivity of buyers to demand Recall Law of Demand as price increases demand decreases Midpoint method end value start value midpoint average X 100 do for percent change in P and Q and plug into price elasticity ratio Determinants Price elasticity is higher when a close substitute is available Ex Breakfast cereals have many substitutes so if price rises buyers will switch to another good Sunscreen has no close substitutes so consumers wouldn t buy in the event of a price increase Price elasticity is higher for narrowly defined goods than for broadly defined goods Ex jeans are a narrowly defined good which means they have many substitutes but clothing is a broadly defined good which means it does not and is not affected by price increase Price elasticity is higher for luxury goods than necessities Ex the demand for insulin a necessity is not affected by a price increase but the demand for cruises a luxury decreases with an increase in price Price elasticity is higher in the long run than the short run because in the long run consumers have time to respond to the price increase Ex in the short run a rise in gasoline prices does little as people do not have time to adjust but in the long run they can prepare smaller cars live closer to work Depends on availability of substitutes necessity v luxury broad or narrow time Elasticity is related to slope so flatter curves have a higher elasticity and steeper curves Demand Curve have a lower elasticity Types Perfectly inelastic no change in quantity D curve is vertical elasticity is 0 and consumers are not sensitive to a change in price Ex insulin Inelastic demand D curve is steep elasticity is less than one price sensitivity is low less change in quantity than price Unit elastic demand D curve is intermediate slope elasticity is one intermediate price sensitivity Q and P change by the same percent Elastic demand D curve is flat elasticity is greater than one price sensitivity is high Q changes more than P Perfectly elastic D curve is horizontal elasticity is infinity price sensitivity is extreme and Q changes but P does not If elasticity is less than one the good is inelastic necessity no close substitutes and if elasticity is greater than one the good is elastic close substitutes Total revenue a price increase increases the revenue made on each unit but decreases the total number of units sold Revenue PXQ If demand is elastic than the elasticity of demand is greater than one and the percent change in Q is greater than change in P so there is a fall in revenue due to lower Q and an increase in revenue from the higher price so revenue falls when D is elastic a price increase causes revenue to fall If demand is inelastic price elasticity is less than one and percent change in P is greater than change in Q so a fall in revenue from lower Q is smaller than an increase in revenue and P increases when D is inelastic a price increase causes revenue to rise Elasticity 1 elastic elasticity 1 inelastic 1 unitary Price elasticity of supply change in quantity supplied change in P how much quantity supplied responds to change in price seller s price sensitivity Supply Curve Types Slope of supply curve is related to price elasticity of supply so the flatter the curve the larger the elasticity and the steeper the curve the smaller the elasticity less sensitive Perfectly inelastic S curve is vertical elasticity is zero because there is no change in Q seller s price sensitivity is zero Inelastic S curve is relatively steep elasticity is less than one price sensitivity is relatively low Q rises less than price Unit elastic S curve has intermediate slope elasticity is one price sensitivity is intermediate percent change in Q is equal to change in P Elastic S curve is relatively flat elasticity is greater than one price sensitivity is high greater percent change in Q than P Perfectly elastic S curve is horizontal elasticity is infinity price sensitivity is extreme Q changes by any but price does not change Determinants of supply The more easily a seller can change the quantity produced the greater the price elasticity For many goods price elasticity of supply is greater in the long run than the short run because firms can build new factories or new firm may enter market Lower production costs and greater productivity increase price elasticity of supply When supply is inelastic an increase in D has a bigger impact on P than Q Ex beachfront property limited supply When supply is elastic a rise in demand has a bigger impact on Q than price Ex cars easy to produce if price is increasing Supply becomes less elastic as quantity rises due to capacity limits Income elasticity of demand change in quantity demanded change in income response of quantity demanded to change in consumer income Recall an increase in income causes an increase in demand for a normal good so for normal goods income elasticity is greater than zero and for inferior goods elasticity is less than zero Cross price elasticity of demand change in quantity demand for good 1 change in price for good 2 response of demand for one good to changes in price of another good For substitutes cross price elasticity is greater than zero Ex an increase in the price of beef causes an increase in demand for chicken For complements bought together cross price elasticity is less than zero Ex an increase in the price of computers causes a decrease in demand for software increase in price of one decreases the demand for other and results in a negative price elasticity Chapter 6 Supply Demand and Government Policies Price ceiling legal maximum on price of good or service Ex rent control Price floor legal minimum on price of good or service Ex minimum wage Taxes the government can make buyers or sellers pay a specific amount on each unit what buyers pay and seller s receive When ceiling is above equilibrium price it is not binding so it has no effect on market outcome When equilibrium price is above ceiling ceiling below equilibrium ceiling is a binding constraint on price and a shortage occurs In the long run supply and demand are more price elastic and the shortage is larger A