Microeconomics Chapter 5

Elastic

Demand is elastic when the percentage change in the quantity demanded is greater than the percentage change in the price of the good or service. The price elasticity of demand is greater than one.

Inelastic

Demand is inelastic when the percentage change in the quantity demanded is less than the percentage change in the price of the good or service. The price elasticity of demand is less than one.

Income Elasticity of Demand

The percentage change in quantity demanded of a good or service divided by the percentage change in income.

Price Elasticity of Demand

The percentage change in quantity demanded of a good or service divided by the percentage change in price.

Price Elasticity of Supply

The percentage change in quantity supplied of a good or service divided by the percentage change in price.

If there is a drought, what would you expect to happen to farmers' revenues?

A drought will decrease supply, increasing the price of agricultural products. If agricultural products have an inelastic demand, then the increase in price will lead to an increase in farmers' incomes.

Necessity

A good or service that is viewed by consumers as a high priority. Consumers tend to be less sensitive to price changes of goods that are assumed to be necessities.

Minimum Wage

A legal minimum for wages (the price of one hour of labor) for most categories of workers.

Rent Control

A policy which sets a legal maximum rent that can be charged for some apartments in some major cities.

Substitutes

Goods or services that consumers consider as serving similar purposes

If a good has an income elasticity of 0.8, what do you expect to happen to the quantity demanded of this good if the country enters a recession?

If income elasticity is 0.8, then the good is a normal good, meaning that as income increases, so does demand for the good, and if income decreases, demand also falls. If we enter a recession, consumer incomes will fall; therefore, the demand for this good will also fall.

Explain in your own words what it means for demand to be elastic or inelastic.

If the percentage change in quantity demanded is greater than the percentage change in price, the ratio of the percentage change in quantity demanded to the percentage change in price is greater than one. The quantity demanded is very sensitive to changes in price and we describe demand is being elastic. If the percentage change in quantity demanded is less than the percentage change in price, the ratio of the percentage change in quantity demanded to the percentage change in price is less than one. The quantity demanded is less sensitive to changes in price and we describe demand is being inelastic.

Which product is more likely to have an elastic supply: ice cream or diamonds?

It is a lot easier for a producer to make more ice cream than it is to mine more diamonds, so the producer of ice cream will be more sensitive to price changes - supply will be more elastic.

Taxes

Mandatory payments to governments from consumers and producers

Why might demand for movies be more elastic in the summer than in the winter?

One possible reason is that there tend to be more things to do in most parts of the country in the summer than in the winter, so movies in the summer have more substitutes than in the winter.

Subsidies

Payments from governments to producers or consumers of specific goods and services.

What are the arguments in favor of raising the minimum wage? Against? Use supply and demand to support the arguments.

Raising the minimum wage will increase the number of workers willing to work and decrease the number of workers businesses want to hire. It will increase the amount of unemployment. However, it will also increase the incomes of those able to find jobs at the minimum wage.

Who really pays the tax (The $1.10 tax on cigarettes for producers)? Is the elasticity of demand relevant here? What do you expect to be the difference between the elasticity of demand for cigarettes between teenagers and adults?

Regardless of which side of the market is assessed the tax, taxes are shared by both consumers and producers. The more price sensitive one side of the market is, the lower proportion of the tax that side will bear. For example, if consumers are very responsive to price changes (relative to producers), then they will bear less of the tax than producers will. In the case of cigarettes, teenagers probably have a more elastic demand than adults since they may not be as addicted.

Compare the likely elasticity of demand for a college education with the likely elasticity of demand for a degree at one specific institution.

Similar reasoning is appropriate here. Demand for a product will always tend to be less elastic than the demand for a specific brand of the same product. There are more substitutes for a specific brand, and thus the specific brand demand should be more elastic, so the demand for a degree at a specific institution will be more elastic than the demand for a degree.

Price Ceiling

The legal maximum price for which a good or service can be sold. Examples include laws limiting apartment rents in some cities.

Price Floor

The legal minimum price at which a good or service can be sold. An example is the federal minimum wage, currently $7.25 per hour.

List some things that influence how sensitive you are to changes in the prices of goods and services you purchase.

The number of substitutes for the good. Your interpretation of how necessary the good is. The percentage of your income spent on a good. The length of time you have to adjust your purchases.

In the question above, two years after the city raised fares, it noticed that revenues were decreasing. What could have happened over the two years to cause consumers to be more sensitive to the higher fares?

They could have found other forms of transportation, or they could have moved closer to their place of employment, or they could have started walking. The longer the period of time, the more likely it is that consumers will find substitutes.

If demand were elastic, an increase of 10 percent in the price might cause a 20 percent decrease in quantity demanded. What would happen to the total revenue in this case?

Think of this as an approximation. Revenues rise by 10 percent due to the increase in price and fall by 20 percent due to the lost sales. Thus, total revenues decline. If we do the calculations, one can see that revenues do actually decrease from $20,000 to $17,600. The initial revenues (100 x $200 ) are $20,000. The new lower revenues (80 x $220) are $17,600.

What would happen to the store's total revenue with this 10 percent price increase if quantity falls by 5 percent?

Think of this as an approximation. Revenues rise by 10 percent due to the increase in price and fall by only 5 percent due to the lost sales, that is, the lower quantity. Thus, overall revenues must increase. (And, in fact, if we do the exact calculations, the initial revenue is 100 x $200 or $20,000. If price increases by 10 percent, the new price is $220, and if quantity falls by 5 percent, the new quantity is 95. Therefore, the new revenue is $20,900, an increase of $900 over the initial revenue.