Chapter 6: Elasticity

What is a perfectly elastic demand?

- The case in which any price increase will cause the quantity demanded to drop to zero. - The demand curve is a horizontal line. - Price elasticity is infinite

What does a low value of price elasticity indicate?

- A low price elasticity indicates a small response of quantity demanded to price. -Economists call this an inelastic demand.

What is the cross-price elasticity of demand?

- A measure of the effect of a change in one good's price on the quantity demanded of the other good. - It is equal to the percent change in the quantity of one good divided by the percent change in the other good's price.

What is price elasticity of supply?

- A measure of the responsiveness of the quantity of a good supplied to the price of the good. - It is the ratio in the percent change in the quantity supplied to the percent change in the price as we move along the supply curve.

What is the midpoint method?

- A technique for calculating the percent change. - Calculate changes in a variable compared with the average, or midpoint of the starting and final values.

What is the price effect?

- After a price increase, each unit sells at a higher price, which tends to raise revenue

What is the quantity effect?

- After a price increase, fewer units are sold, which tends to lower revenue.

What happens to revenue after the price increase of a good with a unit-elastic demand?

- An increase in price does not change total revenue, because the quantity effect and the price effect exactly offset each other.

What happens to revenue after the price increase of a good with an inelastic demand?

- An increase in price increases total revenue, because the quantity effect is weaker than the price effect.

What happens to revenue after the price increase of a good with an elastic demand?

- An increase in price reduces total revenue, because the quantity effect is greater than the price effect.

Why does it matter whether demand is unit-elastic, inelastic, or elastic?

- Because the classification predicts how changes in the price of a good will affect the total revenue earned by suppliers of the good.

Explain how the availability of inputs can affect the price elasticity of supply?

- Elasticity of supply tends to be large when inputs are readily available and can be shifted into and out of production at a relatively low cost --> they can be readily expanded because they don't require and special or unique resources. - Elasticity of supply tends to be small when inputs are difficult to obtain and can be shifted into and out of production only at a relatively high cost --> limited natural resources: gold, copper, agriculture products that only flourish on a certain type of land, renewable resources that can only be exploited to a certain extent

Explain time can affect the price elasticity of supply?

- Elasticity of supply tends to grow larger as producers have more time to respond to a price change. - Long-run price elasticity of supply is often higher than the short-run elasticity. - Given enough time, producers are able to significantly change the amount they produce in response to a price change, even when production involves a limited natural resource, or a costly input. - Short run: a few weeks/months - Long run: several years

If the income elasticity of demand is positive, what can be said about the nature of the good?

- It is a normal good.

If the income elasticity of demand is negative, what can be said about the nature of the good?

- It is an inferior good.

What is the elasticity of demand for the following good? Explain. What is the shape of the demand curve? b. Demand by students for green erasers

- Perfectly elastic, because there exists other substitutes, such as non-green erasers. - The demand curve will be horizontal at a price equal to that of a non-green eraser.

What is the elasticity of demand for the following good? Explain. What is the shape of the demand curve? a. Demand for a blood transfusion by an accident victim

- Perfectly inelastic, because there is not substitute, and it is necessary for survival. - The demand curve will be vertical at a quantity equal to the needed transfusion quantity.

What is a perfectly elastic supply?

- The case in which even a tiny increase or reduction in the price will lead to very large changes in the quantity supplied. -Price elasticity of supply is infinite. - A perfectly elastic supply curve is a horizontal line. - Example: Supply curve for pizza, because pizza ingredients are plentiful

What is a perfectly inelastic demand?

- The case in which quantity demanded does not respond at all to changes in the price. - The demand curve is a vertical line. - Price elasticity is zero.

What is income-elastic?

- The case in which the income elasticity of demand for a good is greater than 1. - When income rises, the demand for the good rises faster than income. - Luxury goods tend to be income-elastic.

What is income-inelastic?

- The case in which the income elasticity of demand for a good is positive, but less than 1. - When income rises, the demand for the good rises, but more slowly then income. - Necessities tend to be income-inelastic.

What is a perfectly inelastic supply?

- The case in which the price elasticity of supply is zero, so that changes in the price of a good have no effect on the quantity supplied. - A perfectly inelastic supply curve is a vertical line. - Example: Supply curve for cell phone frequencies, because the quantity of frequencies suitable for cell phone operation is fixed.

When two goods are strong complements, what can be said about the cross-price elasticity?

- The cross-price elasticity will be a large negative number.

When two goods are weak complements, what can be said about the cross-price elasticity?

- The cross-price elasticity will be a small negative number.

When two goods are strong substitutes, what can be said about the cross-price elasticity?

- The cross-price elasticity will be positive and large.

When two goods are weak substitutes, what can be said about the cross-price elasticity?

- The cross-price elasticity will be positive and small.

What does a high value of price elasticity indicate?

- The higher the price elasticity the more the quantity demanded is responsive to the price. - Economists will say that the demand is high elastic.

Why is price elasticity strictly a negative number?

- The law of demand says that demand curves are downward sloping, meaning that price and quantity demanded always move in opposite directions. - Economists typically report the absolute value of price elasticity.

What is the 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. - Allows us to determine whether a good is a normal or inferior good.

Explain how share of income spent on the good can affect the price elasticity of demand.

- The price elasticity of demand tends to be low if purchasing the good or service does not account for a large portion of spent income. - The price elasticity of demand tends to be high if purchasing the good or service DOES account for a large portion of spent income, because it is worth the time and effort to find a way to reduce demand when price increases.

Explain how whether or not the good is a necessity or a luxury can affect the price elasticity of demand.

- The price elasticity of demand tends to be low if the good is something you must have, example: life-saving hospital ride. - The price elasticity of demand tends to be high if the good is a luxury, something you could easily live without, example: super big plat screen TV.

Explain how the availability of close substitutes can affect the price elasticity of demand.

- The price elasticity of demand tends to be low if there are no close substitutes or if they are very difficult to obtain. - The price elasticity of demand tends to be high if there are other readily available goods that consumers regard as similar and would be willing to consume instead, example: breakfast cereals.

Explain how the elapsed time since a price change can affect the price elasticity of demand.

- The price elasticity of demand tends to increase as consumers have more time to adjust. - The long-run price elasticity of demand is often higher than the short run elasticity.

What is price elasticity of demand?

- The ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve. - Absolute value

What is total revenue?

- The total value of sales of a good or service - Price x Quantity Sold

When is demand unit-elastic?

- When the price elasticity of demand is exactly 1.

When is demand elastic?

- When the price elasticity of demand is greater than 1.

When is demand inelastic?

- When the price elasticity of demand is less than 1.

When is supply unit-elastic?

- When the price elasticity of supply is exactly 1.

When is supply elastic?

- When the price elasticity of supply is greater than 1.

When is supply inelastic?

- When the price elasticity of supply is less than 1.

Does price elasticity change along the demand curve?

- Yes, for the vast majority of goods, the price elasticity of demand changes along the demand curve.

Are each the following statements true or false? Explain. b. Long-run price elasticities of supply are generally larger than short-run price elasticities of supply. As a result, the short-run supply curves are generally flatter than the long-run supply curves.

False. - It is true that long-run price elasticities of supply are generally larger than short-run price elasticities of supply. - But this would mean that the short-run supply curves are generally steeper, not flatter, than the long-run supply curves.

Are each the following statements true or false? Explain. a. If the demand for milk rose, then, in the long run, milk-drinkers would be better off if supply were elastic rather than inelastic.

True. - An increase in demand raises price. - If the price elasticity of milk were low, then relatively low additional quantities would be supplied with the price increase. As a result the price of milk would rise substantially to satisfy the increase demand for milk. - If the price elasticity of supply is high, then there will be a relatively large increase in quantity supplied when the price rises. As a result, the price will only rise a little bit to satisfy the increase in demand for milk.

Are each the following statements true or false? Explain. c. When supply is perfectly elastic, changes in demand have no effect on price.

True. - When supply is perfectly elastic, the supply curve is horizontal. - A change in demand will have no effect on price, it affects only the quantity bought and sold.

For each case, choose the condition that characterizes demand: elastic demand, inelastic demand, or unit-elastic demand. a. Total revenue decreases when price increases.

elastic demand - Consumers are highly responsive to changes in price. - For a rise in price, the quantity effect outweighs the price effect.

What factors determine the price elasticity of supply?

i) Availability of Inputs ii) Time

What are the four main factors that determine elasticity?

i) Whether the good is a necessity or a luxury ii) The availability of close substitutes iii) Share of income spent on the good iv) Time elapsed since price change

For each case, choose the condition that characterizes demand: elastic demand, inelastic demand, or unit-elastic demand. c. Total revenue falls when output increases.

inelastic demand - Consumers are relatively unresponsive to changes in price. - The price effect of a fall in price outweighs the quantity effect.

For each case, choose the condition that characterizes demand: elastic demand, inelastic demand, or unit-elastic demand. d. Producers in an industry find they can increase their total revenues by coordinating a reduction in industry output.

inelastic demand - Consumers are relatively unresponsive to price, so the percent fall in output is relatively smaller than the percent increase in price. - The price effect of a rise in price outweighs the quantity effect.

For each case, choose the condition that characterizes demand: elastic demand, inelastic demand, or unit-elastic demand. b. The additional revenue generated by an increase in quantity sold is exactly offset by revenue lost from the fall in price received per unit.

unit-elastic demand - The revenue lost to the fall in price is exactly equal to the revenue gained from higher sales.