Chapter 4

Total revenue

The amount that consumers pay and sellers receive for goods and services Calculated as: Price of the good × Quantity Sold

If demand is relatively inelastic

We are relatively insensitive to price changes The demand curve is relatively steeper

If demand is relatively elastic

We are relatively sensitive to price changes The demand curve is relatively flatter

Elasticity

A measure of the responsiveness of buyers and sellers to changes in price or income

Price elasticity of demand

A measure of the responsiveness of quantity demanded to a change in price This gives us the sensitivity of the relationship between these two variables

Time and adjustment process

Affects the ability of consumers to respond to changes in prices Long time horizon elastic demand Short time horizon inelastic demand

Necessities versus luxuries

Affects the options the consumer faces Luxuries elastic demand Necessities inelastic demand

Whether the market is broadly or narrowly defined

Affects the options the consumer faces Narrowly defined elastic demand Broadly defined inelastic demand

Share of the budget spent on the good

Determines how much the price change affects the consumer "Big-ticket items" - elastic demand Inexpensive items - inelastic demand

Existence of substitutes

Determines the options consumers have when the price changes Many substitutes -> elastic demand Few substitutes ->inelastic demand

Economists have studied that when the price of chicken increases, people purchase less rice. With these two goods, which of the following is true?

EC < 0, chicken and rice are complements

Determinants of the Price Elasticity of Demand

Existence of substitutes Share of the budget spent on the good Necessities versus luxuries Whether the market is broadly or narrowly defined Time and adjustment process Affects the ability of consumers to respond to changes in prices

Elasticity is related to total revenue

Firms want to know how changing their prices affects their total revenue

A firm will have more production flexibility if it is able to:

Have spare capacity Maintain inventory Relocate easily

Time and adjustment process

Immediate run Suppliers are stuck with what they have on hand; no adjustment

Graphically, we can also show trade-offs when a firm changes the price of its good.

Increase price Good news: Receive higher price per unit Bad news: Sell fewer units Reduce price Good news: Sell more units Bad news: Receive lower price per unit

Income elasticity of demand

Measures how a change in income affects spending

Cross-price elasticity of demand

Measures the responsiveness of the quantity demanded of one good to a change in the price of a related good EC can be positive or negative Substitute goods: EC > 0 Complementary goods: EC < 0

Price elasticity of supply

Measures the responsiveness of the quantity supplied to a change in price

Flexibility of producers

More production flexibility implies firms are more able to respond to changes in price

Short run, long run

Over time, the firm is able to adjust to market conditions. Supply becomes more elastic.

if cross-price elasticity of demand

Positive => substitute goods Negative => complementary goods

Demand is inelastic if

Quantity demanded changes a small amount as the result of a price change Inelastic = "insensitive" or "unresponsive"

Demand is elastic if

Quantity demanded changes significantly as the result of a price change Elastic = "sensitive" or "responsive

less than 0 =>

inferior goods

income elasticity of income

can be positive or negative normal good E1 > 0 necessities 1>E1>0 luxuries E1>1 inferior good E1<0

Suppose that the price of candy bars increases by 100 percent. As a result of this, you decide to purchase 50 percent less candy bars. How would you describe your demand for candy bars?

demand is inelastic

price elasticity of demand If the change in quantity demanded is more than the change in price =>

elastic

In terms of price elasticity of demand, which of the following goods do you think is the least elastic (most inelastic)?

electricity to power your home

perfectly elastic

horizontal, extreme change

Suppose a firm is selling a product at a price on the inelastic portion of the demand line. This firm could increase revenue by doing what?

increasing the price, selling less units

If the change in quantity demanded is less than the change in price =>

inelastic demand

Suppose that Doug receives a pay increase at work, and his income increases by 20 percent. As a result, Doug decides to buy 12 percent less ground beef. For Doug, ground beef is a(n) ________.

inferior good

perfectly inelastic

line is straight vertical. avg change

income elasticity of demand Larger than 1 =>

normal good luxury

Between 0 and 1 =>

normal good necessities

Elasticity measure of the responsiveness

of buyers and sellers to changes in price or income

relatively elastic

slanted. small changes

relatively inelastic

slightly slanted, large change

If the change in quantity demanded equals the change in price =>

unitary