ECP 4703 Ch. 6 Quiz Study Guide
General Linear Demand
Q = a + bP + cM + dPr + eN b is negative c is positive for normal goods is negative for inferior goods d is positive for substitutes is negative for complements e is positive (# is expected)
Total Revenue (TR)
TR = P X Q Total Revenue = (Price) (Quantity) Total paid to producer for a good or service
If price falls along a segment of demand that is price inelastic, an arrow representing the price effect points down and is longer than an arrow for the quantity effect.
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If price rises along a segment of demand that is price elastic, an arrow representing the quantity effect points down and is longer than an arrow for the price effect.
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Marginal revenue is 0 when total revenue is maximized. If Mr is zero, then demand is unitary elastic
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Qd is very sensitive to price
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Slope is constant
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TR is maximized when MR is 0. TRUE
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The absolute value of price elasticity of demand | E | gets smaller as price falls along demand.
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The cross-price elasticity is negative for complementary goods
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The demand for most agricultural products is rather inelastic. When bad weather reduces the size of crops (i.e. supply decreases), the farmers' incomes rise and the MR of selling one more unit of an agricultural product is negative
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The income elasticity of demand is positive for normal goods
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The interval method is used to compute price elasticity when a price change causes a relatively large movement along demand
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The price elasticity of demand varies along a linear demand curve. TRUE
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The shorter the period of time that consumers have to adjust to a change in the price of a good, the less elastic will be demand. TRUE
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When MR < zero, TR decreases as Q increases (P increases); inelastic
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When MR = zero, TR is maximized; unitary
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When MR > zero, TR increases as Q increases (P decreases); elastic
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When MR is negative MR < P, E is less than 1; an increases in price causes TR to rise
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When demand is unitary elastic MR is 0, and the percentage change in quantity equals the percentage change in price.
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if MR is positive, TR increases when Q increases (elastic) If MR is positive, then demand is elastic
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if big ticket item, more sensitive if inexpensive, less sensitive (low elasticity)
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if demand is enelastic, you want to raise prices.
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prices rise, demand is more elastic prices fall, demand is less elastic
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when P falls, E falls when P rises, E rises
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Determinants of elasticity
1) Availability of Substitutes 2) Proportion of income spent on good 3) Time period to adjust
2 ways to calc Elasticity
1. Income Elasticity of Demand Em = c^ M/Q Cross-Price elasticity of demand Exr = d^Pr/Q 2. Demand Equation E^ = b^ (given)
When the price effect dominates the quantity effect, demand is ______
inelastic
Income Elasticity
Em = % chg. in Qd / % chg. in M
Normal Good
Em > 0 Consumption increases with income
Inverse Demand (linear)
P - A + BQ A >0 B < 0
Elastic Demand
% chg. in Qd is higher than % chg. in P
Unitary Elastic Demand
% chg. in Qd is just equal to % chg. in P
Inelastic Demand
% chg. in price is higher than % chg. Qd
Unit Elastic
E = 1 ex. shoes, radios, tv's "Borderline" case -- at max. TR; midpoint halfway
Formulas for Price Elasticity of Linear Demand: Q = a' + bP
E = b P/Q or E = P / P - A
Point Formula
E = chg. in Q / chg. in P x P/Q
If cut prices, then output increases, and revenue increases
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Price Elasticity of Curvilinear Demand Formulas
E = chg. in Q / chg.in P (P/Q) or E = P / P - A -- A is price intercept
Elastic
E > 1 ex. airline travel, restaurant meals, new cars
Price rises, Qty. falls, TR falls Price falls, Qty. rises,TR rises
ELASTIC DEMAND
Point Elasticity of Demand
E^ = b^ P/Q
If firm sells an additional unit of output and TR rises, then MR must be positive and demand must be elastic. If a firm sells an additional unit and TR falls, then MR must be negative and demand must be inelastic.
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If low prices, quantity increases if high prices, quantity decreases
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As quantity increases along the demand curve, demand becomes less elastic. As price falls along the demand curve, demand becomes less elastic.
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Every time cut price, revevue rises and MR falls, TR rises and falls (has to do with elasticity)
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If MR is negative, TR decreases when Q increases. (inelastic) If MR is negative, then demand is inelastic.
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If P rises, Q falls if Q fall, Q rises
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If TR is constant as price changes along a demand curve, then demand is inelastic. FALSE
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which of the following would NOT tend to make demand for a good X more elastic?
A major competitor of good X goes out of business.
If price falls and total revenue falls, demand must be ________
inelastic
Substitutes
Can be used in place of another. (positive)
If price rises and total revenue rises, demand must be ________.
inelastic
Inferior Good
Em < 0 Consumption decreases with income
Inelastic
E < 1 % chg. in Q < % chg. in P Weakly price sensitive
Inelastic
E < 1 ex. cigarettes, coffee, gas (short-run) Less substitutes, less elastic. More substitutes, more elastic.
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E = % change in Qd / % change in P (E is always negative) (Inverse Relationship due to Law of Demand) --Use absolute value (make positive) --The larger the absolute value the more sensitive to change in price.
Unitary Elastic
E = 1 % chg.in Q = % chg.in P
Cross-Price Elasticity of Demand
Exr = % chg. in Qd of good x / % chg. P of good R -- Measures if two goods are: Substitutes or Complements
Price rises, Qty. falls, TR rises Price falls, Qty. rises, TR falls
INELASTIC DEMAND
Marginal Revenue (linear)
MR = A + 2BQ
Which of the following will NOT affect the price elasticity for a product?
The cost of producing the product.
When demand is elastic, a decrease in price causes Qd to _______ and TR to _______
increase; increase
Price rises or price falls there is no change in total revenue
Unitary Elastic
Complements
Used in conjunction with other goods. (negative)
When demand is unitary elastic, a decrease in price causes Qd to ______ and TR to __________
increase; remain the same
Marginal Revenue (MR)
change in TR / change in Q -- Additional revenue received by producing & selling one more unit of output; the slope of TR.
Slope of Demand
chg. in Q / chg. in P
When demand is inelastic, an increase in price causes Qd to ______ and TR to ____________
decrease; decrease
When demand is elastic, an increase in price causes quantity demanded to _______ and total revenue to __________.
decrease; fall
When demand is unitary elastic, an increase in price causes quantity demanded to _______ and total revenue to ________ .
decrease; stay the same
Price Effect
effect on TR when P changes and Q is constant
Quantity Effect
effect on TR when Q changes and P is constant
If quantity decreases and TR falls, demand must be ______
elastic
If quantity increases and TR rises, demand must be _____
elastic
When the quantity effect dominates the price effect, demand is _______
elastic
Point Elasticity
elasticity at a specific price (point) on a demand curve
Cross-Price Elasticity
how responsive Qd is to changes in P of another good; all else constant
Income Elasticity
how sensitive Qd is to change in M; all else constant
Demand Elasticity
how sensitive to changes in the price
When demand is inelastic, a decrease in price causes quantity demanded to _______ and total revenue to _______.
increase; fall
When demand is unitary elastic _______ effect dominates
neither
Inframarginal Units
output that could have sold at a higher price if the price was not lowered to sell additional (marginal) units
Arc Elasticity
price elasticity calculated over an interval in a demand curve/schedule E = (change in quantity/ change in price) / average P/average Q)
When demand is inelastic, the _______ effect dominates the _______ effect.
price; quantity
When demand is elastic, the __________ effect dominates the __________ effects.
quantity; price
When a change in price causes a change in Qd, TR always moves in the ______ direction as the variable (P or Q) having the _______ effect
same; dominant
When a change in price causes a change in quantity demanded, total revenue always moves in the ________ direction as the variable (P or Q) having the ________ effect.
same; dominant
If quantity decreases and TR stays the same, demand must be ________
unit elastic
When the quantity effect and price effect exactly offset one another, demand is _______
unit elastic
If price rises and total revenue stays the same, demand must be ________.
unitary elastic
Elastic
| E | > 1 % chg. Q > % chg. P Very price sensitive / responsive