Economics 1 : DEMAND AND SUPPLY ANALYSIS

Complements goods

Goods that tend to be used together; technically, two goods whose cross-price elasticity of demand is negative.

Demand Curve

Graph of the inverse demand function. A graph showing the demand relation, either the highest quantity willingly purchased at each price or the highest price willingly paid for each quantity.

Inelastic

Said of a good or service when the magnitude of elasticity is less than one. Insensitive to price changes.

Substitutes

Said of two goods or services such that if the price of one increases the demand for the other tends to increase, holding all other things equal (e.g., butter and margarine).

Elasticity and Total Expenditure

So if demand is elastic, a decrease in price is associated with a larger percentage rise in quantity demanded. Although each unit of the good has a lower price, a sufficiently greater number of units are purchased so that total expenditure (price times quantity) would rise as price falls when demand is elastic. If demand is inelastic, however, a given percentage decrease in price is associated with a smaller percentage rise in quantity demanded. Consequently, when demand is inelastic, a fall in price brings about a fall in total expenditure.

Macroeconomics

The branch of economics that deals with aggregate economic quantities, such as national output and national income.

Microeconomics

The branch of economics that deals with markets and decision making of individual economic units, including consumers and businesses.

perfectly inelastic

When the quantity demanded or supplied of a given good is completely insensitive to a change in the value of a specified variable (e.g., price).

perfectly elastic

When the quantity demanded or supplied of a given good is infinitely sensitive to a change in the value of a specified variable (e.g., price).

Elasticity

a general measure of how sensitive one variable is to any other variable, and it is expressed as the ratio of percentage changes in each variable: %∆y/%∆x.

Income Elasticity of Demand

a measure of how much the quantity demanded of a good responds to a change in consumers' income, computed as the percentage change in quantity demanded divided by the percentage change in income

Elasticity of demand

A measure of the sensitivity of quantity demanded to a change in a product's own price: %∆QD/%∆P. This equation expresses the sensitivity of the quantity demanded to a change in price. This measure is independent of the units in which quantity and price are measured. If quantity demanded falls by 8% when price rises by 10%, then the elasticity of demand is simply -0.8. It does not matter whether we are measuring quantity in gallons per week or liters per day, and it does not matter whether we measure price in dollars per gallon or euros per liter; 10% is 10%, and 8% is 8%. So the ratio of the first to the second is still -0.8.

Elasticity of supply

A measure of the sensitivity of quantity supplied to a change in price: %∆QS/%∆P.

Demand function

A relationship that expresses the quantity demanded of a good or service as a function of own-price and possibly other variables. It is often desirable to concentrate on the relationship between the dependent variable and just one of the independent variables at a time. To accomplish this goal, we can hold the other independent variables constant and rewrite the equation.

Inverse demand function

A restatement of the demand function in which price is stated as a function of quantity.

What characteristics of a good or its market might be informative in determining whether demand is highly elastic?

Perhaps the most important characteristic is whether there are close substitutes for the good in question. If there are close substitutes for the good, then if its price rises even slightly, a consumer would tend to purchase much less of this good and switch to the less costly substitute. If there are no substitutes, however, then it is likely that the demand is much less elastic.

Cross-price elasticity of demand (XED)

The percentage change in quantity demanded for a given percentage change in the price of another good; the responsiveness of the demand for Product A that is associated with the change in price of Product B.

Own price

The price of a good or service itself (as opposed to the price of something else).

law of demand

The principle that as the price of a good rises, buyers will choose to buy less of it, and as its price falls, they will buy more.