CHAPTER 6: DESCRIBING SUPPLY & DEMAND: ELASTICITIES

What factors affect the Number of Substitutes a good has?

1- The time period being considered (longer results in more substitutes) 2- The degree to which the good is a luxury (luxuries have more substitutes) 3- The definition of the Market (local has more substitutes) 4- The importance of the good in your budget (larger % of your budget tends to have more substitutes)

What is a "Normal Good"?

A Normal Good is one whose consumption increases as Incomes increase Example: When you get a raise at work, you have more money to spend, so the Quantity of Movies you go to also increases

What is an "Inferior Good"?

An Inferior Good is a good where consumption DECREASES when Income INCREASES Example: If you get a raise at work, you have more money to spend and might choose to buy more branded sodas instead of generic sodas at the grocery store. Thus the generic soda is an inferior good

What is "Cross Price Elasticity of Demand?"

Cross Price Elasticity of Demand is: % Change in Demand divided by % Change in the Price of a RELATED GOOD Example: Say the price of an iPhone goes up. The Price of an Android phone is also likely to go up, so the Cross Price Elasticity of Demand between the iPhones and Android phones is Positive

Is there a Price Elasticity of Demand number that separates Elastic goods from Inelastic ones?

Elastic goods have a Price Elasticity of Demand > 1 Inelastic goods (like water) have a Price Elasticity of Demand < 1 Note that the change in Quantity Demanded for Inelastic goods goes down by less than the Change in Price (that's why it's < 1)

What does "Perfectly Elastic" mean?

For Perfectly Elastic goods, the Quantity Demanded responds ENORMOUSLY to the slightest change in Price. The Demand Curve graph of a Perfectly Elastic good is a HORIZONTAL (left to right) LINE

What does "Perfectly Inelastic" mean?

For Perfectly Inelastic goods, the Quantity Demanded does NOT RESPOND AT ALL to ANY change in price The Demand Curve graph of a Perfectly Inelastic good is a VERTICAL (up and down) LINE (HINT: Think of a letter "I" for Inelastic)

What does "Unit Elastic" mean?

For Unit Elastic goods, the Price Elasticity of Demand = 1.0, meaning that the % Change in Quantity Demanded will equal the % Change in Price

If a good has a lot of Substitutes, does it affect Price Elasticity of Demand?

Goods that have a lot of Substitutes tend to be MORE Elastic. Think about it: If the Price of Margarine goes up by 5% while the Price of Butter doesn't change, I can easily substitute Butter for Margarine.

How does Price Elasticity of Demand affect a Suppliers' Revenue?

If demand is Elastic (>1), a rise in price LOWERS revenues If demand is Unit Elastic (=1), a rise in price has no effect on revenue If demand is Inelastic (<1), a rise in price INCREASES total revenue

What is "Income Elasticity of Demand"?

Income Elasticity of Demand is: Percentage Change in Demand divided by Percentage Change in Income

What does Income Elasticity of Demand tell us?

Income Elasticity of Demand tells us how sensitive Demand is in response to a change in Income. Note, the numerator measures a Change in Demand, NOT Quantity Demanded! Remember, anything other than Price that changes Demand causes the WHOLE Demand Curve to SHIFT!

Is Elasticity of Demand the same as the Slope of the Demand Line?

NO. The Elasticity of Demand (& also of Supply) CHANGES at different points along the curve. Think about it. If the price of Bubble Gum went up by 5%, you might buy 10% less bubble gum (elasticity = 0.05 / 0.10 = 0.5), but if the price went up by 75%, you might buy 90% less Gum (elasticity = 0.90 / 0.75 = 1.2)

If the Cross Price Elasticity of Demand between two products is Negative, what does that mean?

Negative Cross Price Elasticity of Demand between two products means the products are likely COMPLIMENTS

How do we "see" revenue on the graph of the Demand Curve?

On the Demand Curve graph, Revenue is represented by the AREA of the rectangle formed by starting at the origin in the bottom left and ending at the (X,Y) (or Qty, Price) coordinate in the upper right hand corner

What is the formula to calculate Percentage Change?

Percentage Change = (End Value divided by Beg Value) - 1 <OR> (End Val - Beg Val) divided by Beg Val

If the Cross Price Elasticity of Demand between two products is Positive, what does that mean?

Positive Cross Price Elasticity of Demand between two products means the products are likely SUBSTITUTES

What does Price Elasticity of Demand tell us?

Price Elasticity of Demand tells us HOW SENSITIVE the Quantity Demanded is to a Change in Price Example: A 10% increase in the price of new shoes might cause you to demand (buy) fewer shoes, but a 10% increase in the price of water likely will not have an effect on how much water you demand...

How does a Supplier calculate Revenue?

Revenue = Price per unit x Quantity sold Example: If a store sells Hot Dogs for $2.00 each, and sells 30 Hot Dogs in one day, their revenue for that day was $2.00 x 30 = $60.00

Example of Price Elasticity of Demand

Say the Price of shoes RISES by 10%, and the Quantity Demanded FALLS by 20% in response. The Price Elasticity of Demand for Shoes is therefore = (-0.20 / 0.10) = 2 Wait, shouldn't it be = -2? No, because we always measure the Price Elasticity of Demand in ABSOLUTE VALUE terms

What are the two categories of Normal Goods?

The 2 categories of Normal Goods are: 1: Luxuries -- Goods that have an Income Elasticity > 1 2: Necessity -- Goods that have an Income Elasticity between 0 and 1

How should I interpret the number of Price Elasticity of Demand?

The LARGER the Price Elasticity of Demand is, the MORE SENSITIVE the Quantity Demanded is to a Change in Price Our earlier example said the Price Elasticity of Demand for shoes was 2. This means when the Price of shoes goes UP by 1%, the Quantity Demanded goes DOWN by 2 times that amount or by 2%. What if instead Price Elasticity of Demand were 0.3 and the Price increased by 10%, how much would the Quantity Demanded change by? It would go down by 0.10 x 0.3 = 0.03 or only 3%

What is the "Price Elasticity of Demand"?

The Price Elasticity of Demand is: Percentage Change in Quantity Demanded divided by Percentage Change in Price

How does a Shift of the Supply Curve affect a good with Elastic Demand?

The more elastic the Demand is, the GREATER the effect of a Supply shift on Quantity and the SMALLER the effect on Price