Ch 6 Elasticity

Homework

A price increase will cause a decrease in total revenue when demand is elastic. When demand is inelastic, price and total revenue move in the same direction. This happens because inelastic demand means that consumers are not very sensitive to changes in price. Specifically, when price changes, the percentage change in quantity will be less than the percentage change in price. This causes total revenue (P x Q) to move in the same direction as the change in P. Thus, when price increases, so does revenue. The price effect outweighs the quantity effect. When demand is elastic, price and total revenue move in opposite directions. In the elastic region of the demand curve, consumers are highly sensitive to changes in price. Specifically, when price changes, the percentage change in quantity demanded will be larger than the percentage change in price. Thus, when price decreases, revenue increases, and when price increases, revenue decreases. The quantity effect outweighs the price effect. Finally, when demand is unit elastic, total revenue remains constant when the price changes, because the change in quantity demanded is proportionately equal to the change in price. The price effect and the quantity effect exactly offset each other. When the price increases from $20 to $30 per pole, the price effect is stronger than the quantity effect because the revenue increases from $320 to $420

Factors affecting the Elasticity of Demand are:

Availability of substitutes, lots of them=high, few options =low. Necessity = low, Luxury = High. Share or percent of your income spent on a good is small=low, a lot or large percent=high. Time elapsed since last price change, small=low, long=high.

The Midpoint Method

Average price; the average of the new price and the initial price.The percentage change in price calculated by the midpoint method is the same, absolute value, drop the minus sign, for a price rise and a price fall ((% change in price = [(New price-Initial price) ÷ [(New price + Initial price) ÷ 2]] x 100))

cross price elasticity of demand

a measure of how much the quantity demanded of one good responds to a change in the price of another good, computed as the percentage change in quantity demanded of the first good divided by the percentage change in the price of the second good

price elasticity of supply

a measure of how much the quantity supplied of a good responds to a change in the price of that good. Computed as the percentage change in quantity supplied divided by the percentage change in price, as you move along the supply curve.

A positive percent change in price, a raise in price, leads to

a negative percent change in the quantity demanded.

short run

a period of time sufficiently short that at least one of the firm's factors of production cannot be varied; plant capacity is fixed

A fall in price leads to

a positive percent change, a rise, in quantity demanded.

total revenue test

a test to determine elasticity of demand between any two prices: Demand is elastic if total revenue moves in the opposite direction from price; it is inelastic when it moves in the same direction as price; and it is of unitary elasticity when it does not change when the price changes

long run

a time period long enough for firms to adjust their plant sizes and for new firms to enter (or existing firms to leave) the industry

The Law of Demand says that demand curves are downward sloping, so price and quantity always move

in opposite directions.

Elasticity

is a comparison of two different percentages. It shows you how much the quantity demanded or supplied changes as a result of changes in price or income. It's represented as a number; like .2, .85 or 1.3. It is not represented as a percentage.

individual consumer surplus

is the net gain to an individual buyer from the purchase of a good; it is equal to the difference between the buyer's willingness to pay and the price paid

(sellers) cost

lowest price at which he or she is willing to sell a good

unit elastic demand

price elasticity of demand is exactly 1

elastic demand

price elasticity of demand is greater than 1

inelastic demand

price elasticity of demand is less than 1

Elasticity of Demand is assumed to be

taken as a given & assumed to stay consistent and correct unless otherwise stated; if it's 2 before a price change, it will still be 2 after a price change.

When the price elasticity of demand is large, or more than 1

that demand is highly elastic

tax incidence

the actual division of the burden of a tax between buyers and sellers in a market

utility

the amount of satisfaction one gets from a good or service

marginal utility

the change in total utility a person receives from consuming one additional unit of a good or service

deadweight loss

the fall in total surplus that results from a market distortion, such as a tax

willingness to pay

the maximum amount that a buyer will pay for a good

The larger the price elasticity of demand

the more responsive the quantity demanded is to the price.

individual producer surplus

the net gain to an individual seller from selling a good; it is equal to the difference between the price received and the sellers cost

income elasticity of demand

the percent change in the quantity of a good demanded when a consumer's income changes divided by the percent change in the consumer's income

market period

the period that occurs when the time immediately after a change in market price is too short for producers to respond

diminishing marginal utility

the principle that our additional satisfaction, or our marginal utility, tends to go down as more and more units are consumed

utility maximizing rule

the principle that to obtain the greatest utility, the consumer should allocate money income so that the last dollar spent on each good or service yields the same marginal utility; also known as the optimal consumption rule

When the price elasticity of demand is small, or less than 1

the quantity demanded will fall by a relatively small amount when prices rise. This is Inelastic Demand.

price elasticity of demand

the ratio of the percent change in quantity demanded to the percentage change in its price as you move along the demand curve. It is the best measure of how the quantity demanded responds to change in price of a product or resource.

total surplus

the sum of consumer surplus and producer surplus; the total net gain to producers and consumers from trading in a market

total consumer surplus

the sum of the individual consumer surpluses of all the buyers of a good in the market

total producer surplus

the sum of the individual producer surpluses of all the sellers of a good in a market

total revenue

the total value of the sale of a good or service; it is equal to the price multiplied by the quantity sold

perfectly elastic demand

when any price increase will cause the quantity demanded to drop to zero; the demand curve is a horizontal line

perfectly inelastic demand

when the quantity demanded does not respond at all to changes in the price; the demand curve is a vertical line