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
