MICROECONOMICS QUIZ 2: Chapters 5-7Chapter 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 demandedresponds 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. Demand Curve: - Elasticity is related to slope so flatter curves have a higher elasticity and steeper curves 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 anincrease 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: - 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). Types:- 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, Qchanges by any % but price does not change. Determinants:- The more easily a seller can change the quantity produced, the greater the price elasticity of supply. - 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 PoliciesPrice 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