FPC1 Changes in Supply and Demand

Market Failure

A situation in which the market delivers an inefficient outcome.

Income Elasticity of Demand

A measure of the responsiveness of the demand for a good to a change in income when other things remain the same. * Greater than 1 (normal good, income elastic) • Between zero and 1 (normal good, income inelastic) • Less than zero (inferior good)

Cross Elasticity of Demand

A measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement when other things remain the same.

Price Elasticity of Demand

A measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buyers' plans remain the same.

Total Revenue Test

A method of estimating the price elasticity of demand by observing the change in total revenue that results from a price change (with all other influences on the quantity sold remaining unchanged).

Proportion of Income Spent

A price rise, like a decrease in income, means that people cannot afford to buy the same quantities of goods and services as before. The greater the proportion of income spent on a good, the greater is the impact of a rise in its price on the quantity of that good that people can afford to buy and the more elastic is the demand for the good. For example, toothpaste takes a tiny proportion of your budget and housing takes a large proportion. If the price of toothpaste doubles, you buy almost as much toothpaste as before. Your demand for toothpaste is inelastic. If your apartment rent doubles, you shriek and look for more roommates. Your demand for housing is more elastic than is your demand for toothpaste.

Allocative Efficiency

A situation in which the quantities of goods and services produced are those that people value most highly—it is not possible to produce more of a good or service without giving up some of another good that people value more highly.

Command System

A system that allocates resources by the order of someone in authority.

Elasticity Along a Linear Demand Curve

Along a linear demand curve, • Demand is unit elastic at the midpoint of the curve. • Demand is elastic at all points above the midpoint of the curve. • Demand is inelastic at all points below the midpoint of the curve.

Total Revenue

The amount spent on a good and received by its seller and equals the price of the good multiplied by the quantity sold.

Production Possibilities Frontier

The boundary between the combinations of goods and services that can be produced and the combinations that cannot be produced, given the available factors of production and the state of technology.

Deadweight Loss

The decrease in total surplus that results from an inefficient underproduction or overproduction.

Narrowness of Definition

The demand for a narrowly defined good is elastic. For example, the demand for a Starbucks latte is elastic because a New World latte is a good substitute for it. The demand for a broadly defined good is inelastic. For example, the demand for coffee is inelastic because tea is a poor substitute for it.

Time Elapsed Since Price Change

The longer the time that has elapsed since the price of a good changed, the more elastic is the demand for the good. For example, when the price of gasoline increased steeply during the 1970s and 1980s, the quantity of gasoline demanded didn't change much because many people owned gas-guzzling automobiles—the demand for gasoline was inelastic. But eventually, fuel-efficient cars replaced gas guzzlers and the quantity of gasoline demanded decreased—the demand for gasoline became more elastic.

Consumer Surplus

The marginal benefit from a good or service in excess of the price paid for it, summed over the quantity consumed.

Transaction Costs

The opportunity costs of making trades in a market.

Percentage Change in Quantity Demanded

The percentage change in the quantity demanded using the midpoint method is Percentage change in quantity ; equals open parenthesis New quantity − Initial quantity over open parenthesis New quantity plus Initial quantity close parenthesis ÷ 2 close parenthesis × 100 ; equals open parenthesis 5 − 15 over open parenthesis 5 plus 15 close parenthesis ÷ 2 close parenthesis × 100 equals open parenthesis − 10 over 20 ÷ 2 close parenthesis × 100 ; equals open parenthesis − 10 over 10 close parenthesis × 100 equals − 100 percent. ;

Percentage Change In Price

The percentage change is calculated as the change in price divided by the initial price, all multiplied by 100. The formula for the percentage change is: Percentage change in price equals (New price − Initial price/Initial price)× 100.

Producer Surplus

The price of a good in excess of the marginal cost of producing it, summed over the quantity produced

Total Surplus

The sum of producer surplus and consumer surplus.

The Midpoint method

To calculate the percentage change in price using the midpoint method, we divide the change in the price by the average price—the average of the new price and the initial price—and then multiply by 100. The average price is at the midpoint between the initial and the new price, hence the name midpoint method. The formula for the percentage change using the midpoint method is Percentage change in price equals open parenthesis New price − Initial price over open parenthesis New price plus Initial price close parenthesis ÷ 2 close parenthesis × 100.

Computing the Price Elasticity of Demand

To determine whether the demand for a good is elastic, unit elastic, or inelastic, we compute a numerical value for the price elasticity of demand by using the following formula: Price elasticity of demand equals Percentage change in quantity demanded over Percentage change in price • If the price elasticity of demand is greater than 1, demand is elastic. • If the price elasticity of demand equals 1, demand is unit elastic. • If the price elasticity of demand is less than 1, demand is inelastic.

Luxury Versus Necessity

We call goods such as food and housing necessities and goods such as exotic vacations luxuries. A necessity has poor substitutes—you must eat—so the demand for a necessity is inelastic. A luxury has many substitutes—you don't absolutely have to go to the Galapagos Islands this summer—so the demand for a luxury is elastic.

Unit Elastic Demand

When the percentage change in the quantity demanded equals the percentage change in price.

Elastic Demand

When the percentage change in the quantity demanded exceeds the percentage change in price

Inelastic Demand

When the percentage change in the quantity demanded is less than the percentage change in price.

Perfectly Inelastic Demand

When the percentage change in the quantity demanded is zero for any percentage change in the price.

Unit Elastic Supply

When the percentage change in the quantity supplied equals the percentage change in price.

Elastic Supply

When the percentage change in the quantity supplied exceeds the percentage change in price.

Inelastic Supply

When the percentage change in the quantity supplied is less than the percentage change in price.

Perfectly Inelastic Supply

When the percentage change in the quantity supplied is zero for any percentage change in the price.

Perfectly Elastic Demand

When the quantity demanded changes by a very large percentage in response to an almost zero percentage change in price.

Perfectly Elastic Supply

When the quantity supplied changes by a very large percentage in response to an almost zero percentage change in price.

Computing the Price Elasticity of Supply

o determine whether the supply of a good is elastic, unit elastic, or inelastic, we compute a numerical value for the price elasticity of supply in a way similar to that used to calculate the price elasticity of demand. We use the formula: Price elasticity of supply equals Percentage change in quantity supplied over Percentage change in price