Chapter 5 Questions for Review - Demand and Supply
List and explain the four determinants of the price elasticity of demand.
Availability of close substitutes - Items with close substitutes are more elastic (butter vs. margarine) than items without a close substitute (eggs, less elastic). Necessities vs. Luxuries - Luxuries normally have higher elastic demands, whereas necessities tend to have inelastic demands. Calling a good a necessity or luxury ultimately lies within the buyer's control. Definition of the market - Narrowly defined markets tend to have more elastic demand while broadly defined markets tend to have less elastic demand. The elasticity all depends on how we draw the boundaries of a market. Time Horizon - Items tend to have a more elastic demand over a larger timeframe. When the price of gasoline rises, eventually people will start buying more fuel efficient cars.
If the elasticity is greater than 1, is demand elastic or inelastic? If the elasticity equals zero, is demand perfectly elastic or perfectly inelastic?
If elasticity is great than 1, the demand is elastic, meaning an increase in price results to a decrease in quantity demanded. If elasticity is equal to zero, the demand is perfectly inelastic, meaning an increase in price leaves the quantity demanded unchanged.
If a fixed quantity of a good is available, and no more can be made, what is the price elasticity of supply?
If there is a set amount of beachfront land available and for the most part no more can be made, it has an inelastic supply, more specifically a perfectly inelastic supply where elasticity of supply equals 0. An increase of price of this property leaves the quantity supplied unchanged.
Define the price elasticity of demand and the income elasticity of demand.
Price elasticity of demand is a measure of how much the quantity demanded responds to a change in price. This is measured by the % change in quantity demanded divided by the % change in price. Reflecting this, income elasticity of demand is a measure of how much a quantity demanded responds to a change in consumers' income. It is represented by the % change in quantity demanded divided by the % change in income.
How is the price elasticity of supply calculated? What does it measure?
Price elasticity of supply is calculated as the percentage change in the quantity supplied divided by the percentage change in the price. It measures how much the quantity supplied of a good responds to a change in the price of that good. It also determines whether the supply curve is steep or flat.
A storm destroys half the fava bean crop. Is this event more likely to hurt fava bean farmers if the demand for fava beans is very elastic or very inelastic?
This storm would hurt farmers more if the demand was elastic. If demand was inelastic for their products, farmers receive greater total revenue as a group if they supply a smaller crop to the market. This would be better for the farmers if the storm destroyed half of ALL the farmer's crop rather than an individual farmer.
What do we call a good with an income elasticity less than zero?
We call this type of good an inferior good. As discussed in Chapter 4, an inferior good is a product you buy more of when your income falls. Necessities have small income elasticities while luxuries normally have high income elasticities.
If demand is elastic, how will an increase in price change total revenue?
When demand is elastic, an increase in price will reduce total revenue. Breaking it down, when the demand curve is elastic the extra revenue from selling at a higher price is less than the lost revenue from selling fewer units.