Micro ch. 5

demand for food is

income inelastic and price inelastic. this combination of income and price inelasticity creates special problems for farmers

If the cost of supplying additional units rises sharply as output expands, then a higher price causes little increase in quantity supplied, so supply tends to be

inelastic

total revenue

price multiplied by quantity demanded at that price

when demand is inelastic a price decrease

reduces total revenue bc the gain in revenue from selling more units is less than the loss in revenue selling all units at the lower price

if demand is unit elastic

the percentage increase in quantity demanded just equals the percentage decrease in price, so total revenue remains unchanged

if the demand is elastic

the percentage increases in quantity demanded exceeds the percentage decrease in price, so total revenue increases

if demand is inelastic

the positive impact of an increase in quantity demanded on total revenue is more than offset by the negative impact of a decrease in price, so total revenue falls

constant elasticity demand curve

the type demand that exists when price elasticity is the same everywhere along the curve; elasticity value is unchanged

Elasticity measures

the willingness and ability of buyers and sellers to alter their behavior in response to changes in their economic circumstances

consistent relationship between the price elasticity of demand and total revenue:

-a price declines increases total revenue if demand is elastic -has no effect on total revenue if demand is unit -decreases total revenue if demand is inelastic

depending on how responsive quantity demand is to a change in price, ranges of elasticity can be divided into three categories:

-inelastic -unit elastic -elastic

determinants of supply elasticity

-length of adjustment period under consideration a) the elasticity of supply is typically greater the longer the period of adjustment

income elasticity of demand

-the percentage change in demand divided by the percentage change in consumer income; the value is positive for normal goods and negative for inferior goods -income elasticity of demand measures the percentage change in demand divided by the percentage change in income that caused it

elastic demand

a change in price has a relatively large effect on quantity demanded; the percentage change in quantity demanded exceeds the percentage change in price; the resulting price elasticity has an ABSOLUTE VALUE EXCEEDING 1.0

inelastic demand

a change in price has relatively little effect on quantity demanded; the percentage change in quantity demanded is less than the percentage change in price; the resulting price elasticity has an ABSOLUTE VALUE LESS THAN 1.0

perfectly elastic supply curve

a horizontal line reflecting a situation in which any price decrease drops the quantity supplied to zero; the elasticity value is infinity -as individual consumers we typically face perfectly elastic supply curves. when we go to the store we can usually buy as much as we want at the posted price but none at a lower price. all consumers together cannot buy an unlimited amount at the prevailing price

perfectly elastic demand curve

a horizontal line reflecting a situation in which ay price increase would reduce quantity demanded to zero; the elasticity has an absolute value of infinity

the halfway point divides

a linear demand curve into an elastic upper half and an inelastic lower half

unit-elastic supply curve

a percentage change in price causes an identical percentage change in quantity supplied; depicted by a supply curve that is a straight line from the origin; the elasticity value equals 1.0

elastic supply

a price change has a relatively large effect on quantity supplied; the percentage change in quantity supplied exceeds the percentage change in price; the price elastcity of supply exceeds 1.0

inelastic supply

a price change has relatively little effect on quantity supplied; the percentage change in quantity supplied is less than the percentage change in price; the price elasticity of supply is less than 1.0

linear demand curve

a straight-line demand curve; such a demand curve has a constant slope but usually has a varying price elasticity

perfectly inelastic supply curve

a vertical line reflecting a situation in which a price change has no effect on the quantity supplied; the elasticity value is zero -pablo picasso and elvis presleys cadillacs

perfectly inelastic demand curve

a vertical line reflecting a situation in which any price change has no effect on the quantity demanded; the elasticity value is zero

bc spending on some goods claims a large share of the consumer's budget, a change in the price of such a good has a substantial impact on the consumers

ability to buy it. for ex: an increase in the price of housing reduces the ability to buy housing

even though elasticity will always be a negative number we treat it as a

absolute number

downward sloping linear curve has a

constant slope but a varying elasticity, so the slope of a demand curve is not the same as the price elasticity of demand

Because the demand curve is linear its slope is

constant, so a given decrease in price always causes the same unit increase in quantity demanded

if the demand curve is linear,

consumer are more responsive to a given price change when the initial price is high than when it is low

the price elasticity of demand is greater in the long run bc

consumers have more time to adjust. for ex: if the price of electricity rose today, consumers in the short time might cut back a bit in their use of electrical appliances, and those in homes with electric heat might lower the thermostat in winter. over time, however, consumers would switch to more energy efficient appliances, insulate their homes better and perhaps switch from electric heat. so the demand for electricity is more elastic in the long run than in the short run

the number and similarity depend on how the good is

defined

normal goods

demand for most goods increase or shift rightward as income increases. have income elasticities greater than zero

in every instance where estimates for both short run and long run are available,

demand is more elastic in the long run than the short run is

their response depends on how

easy it is to alter quantity supplied if the price changes

If the marginal cost rises slowly as output expands, the lure of a higher price prompts a large increase in quantity supplied, so supply tends to be

elastic

constant elasticity demand curves

elasticity does not change along the curves

much advertising is aimed at

establishing in the consumer's mind the uniqueness of a particular product- an effort to convince consumers to accept no substitutes

unit elastic demand curve

everywhere along the demand curve, the percentage change in price causes an equal but offsetting percentage change in quantity demanded, so total revenue remains the same; the elasticity has an absolute value of 1.0

income inelastic necessities

food, rent. normal goodswith income elasticities less than one

inferior goods

goods with income elasticities less than zero. shifts leftward furniture and clothes.

income elastic

goods with income elasticity greater than 1. luxuries: fine wine, high end cars

a firms success or failure often depends on

how much it knows about the demand for its producer

complements

if an increase in the price of one good leads to a decrease in the demand for another, their cross-price elasticity is negative and the goods are complements EX: an increase of gas, other things constant, shifts the demand for tires leftward bc people drive less and replace their tires less frequently. They have a negative cross price elasticity

substitutes

if an increase in the price of one good leads to an increase in the demand for another good, their cross price elasticity is positive and the two goods are substitutes. EX: increase in the price of coke, other things constant, shifts the demand for pepsi rightward, so the two are substitutes

knowledge of price elasticity of demand is especially valuable to produces bc

it indicates how a price change affects total revenue

when we move down the curve, demand becomes

less elastic

certain goods-some perscription drugs- have no close substitutes. the demand for such goods tend to be

less elastic than for goods with close substitutes, such as bayer aspirin.

What happens to the total revenue when price decreases?

lower price increases quantity demanded, which tends to increase total revenue. but a lower price means producers get less for each unit sold, which tends to decrease total revenue. the overall impact of a lower price on total revenue therefore depends on the et result these opposite effects. IF THE POSITIVE EFFECT OF A GREATER QUANTITY DEMANDED MORE THAN OFFSETS NEGATIVE EFFECT OF A LOWER PRICE, THEN TOTAL REVENUE WILL RISES.

Because the focus is on the percentage change, we dont need to be concerned with how output or price is

measured. -for example: If the good is apples, it makes no difference in the elasticity formula whether we measure apples in pounds, bushels, or even tons. all that matters is the percentage change in quantity demanded. and it doesnt matter if we measure the price in us dollars, pesos, or euros, all that matters is the percentage change in price

Price elasticity of demand

measures how responsive quantity demanded is to a price change; the percentage change in quantity demanded divided by the percentage change in price

price elasticity of supply

measures the responsiveness of quantity supplied to a price change;the percentage change in quantity supplied divided by the percentage change in price

price elasticity formula

percentage change in quantity demanded divided by the percentage change in price; the average price are used as bases for computing percentage changes in quantity and in price

price elasticity of demand=

percentage change in quantity of demand/ percentage change in price

The elasticity of supply indicates how

responsive producers are to a change in price

elasticity is another word for

responsiveness

In the elasticity formula the numerator and denominator have opposite

signs, leaving the price of elasticity of demand with a negative sign.

The law of demand states

that the price and quantity demanded are inversely related so the change in price and change in quantity demanded move in opposite directions

when demand is unit elastic

the gain and loss of revenue exactly cancel each other out, so total revenue at that point remains constant

the more important the item is as a share of the consumers budget, other things constant,

the greater is the income effect of a change in price, so the more elastic is the demand for the item

The greater the availability of substitutes and the more similar theses substitutes are to the good in question,

the greater the good's price elasticity is demand

total revenue increases as the price declines until

the midpoint of the linear demand curve is reached, where total revenue peaks

the longer the period of adjustment,

the more responsive the change in quantity demanded is to a given change in price

the more narrow the definition

the more substitutes and this the more elastic the demand. for ex: the demand for post raisin bran is more elastic that the demand for raisin bran more generally bc there are more substitutes for post raisin bran, including kellogs raisin bran and total raisin bran, than for raisin bran more generally. the demand for raisin bran however is more elastic than the demand for breakfast cereals more generally bc the consumer has many subsitutes for raisin bran such as cereal made from corn, rice, wheat, or oats.

elasticity expresses a relationship between two amount:

the percentage change in quantity demanded and the percentage change in price

unit elastic demand

the percentage change in quantity demanded equals the percentage change in price; the resulting price elasticity has AN ABSOLUTE VALUE OF 1.0

unit elastic supply

the percentage change in quantity supplied equals the percentage change in price; the price of elasticity of supply equals 1.0

cross price elasticity of demand

the percentage change in the demand of one good divided by the percentage change in the price of another good; its positive for substitutes, negative for complements, and zero for unrelated goods

when demand is elastic, a decrease in price increases

total revenue bc the gain in revenue from selling more units exceeds the loss in revenue from selling more units

inferior goods, necessities, and luxuries are not

value judgments about merits of particular goods; these terms are convenient way of classifying economic behavior

if demand is inelastic a producer will never

willingly cut the price bc doing so would reduce total revenue. the percentage increase in quantity demanded would be less than percentage decrease in price