Formula for Price Elasticity of Demand
(Price Elasticity of Demand) = (Percentage Change in Quantity Demanded / Percentage Change in Price)
Def of
... [Show More] Perfectly Inelastic Demand
If the quantity demanded remains constant when the price changes, then the price elasticity of demand is zero. Thus, the quantity demanded is constant regardless of the price; insulin and other necessities are good examples. Elasticity = 0 is graphed with a vertical line with undefined slope.
Def of Unit Elastic Demand
If the percentage in the quantity demanded equals the percentage change in the price.
Def of Inelastic Demand
When the percentage change in quantity demanded is less than the percentage change in price. Thus, the price elasticity of demand is between 0 and 1.
Def of Perfectly Elastic Demand
If the quantity demanded changes by an infinitely large percentage in response to a tiny price change. Imagine two soda machines, one with a higher price than the other; everyone is going to buy from the cheaper one.
Def of Elastic Demand
When the percentage change in the quantity demanded exceeds the percentage change in price; the price elasticity of demand is greater than 1; automobiles and furniture are good examples.
Elasticity Along a Demand Curve
The midpoint represents the unitary elasticity; points above the midpoint are elastic while points below are all inelastic.
Def of Total Revenue
The total revenue from the sale of a good equals the price of a good multiplied by the quantity sold.
Total Revenue Test
The test is a method of estimating the price elasticity of demand by observing the change in total revenue that results from a change in the price. When demand is elastic, a price cut increases total revenue; when demand is inelastic, a price cut decreases total revenue.
Cross Elasticity of Demand
Is the measure of the responsiveness of the demand for a good to a change in the price of a substitute or complement, other things remaining the same. The formula is: (Cross Elasticity of Demand) = (Percentage Change in Quantity Demanded / Percentage Change in Price of Substitute or Complement).
Cross Elasticity of Demand with Substitutes and Complements
If the CED is positive, then the two are substitutes; if it is negative, they are complements.
Def of Income Elasticity of Demand
A measure of the responsiveness of the demand for a good or service to a change in income, other things remaining the same. Formula: (Income Elasticity of Demand) = (Percentage Change in Quantity Demanded / Percentage Change in Income).
Income Elasticity Categories
If the IED is greater than 1, it is a NORMAL good and is income elastic. If IED is 0 < x < 1 then it is a normal good and income inelastic. If IED is negative, it is an inferior good.
Def of Income Elastic Demand
When the demand for a good is income elastic, the percentage of income spent on that good increases as income increases.
Def of Income Inelastic Demand
When the demand for a good is income inelastic, the percentage of income spent on that good decreases as income increases.
Def of Elasticity of Supply
Measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same. Formula: (Elasticity of Supply) = (Percentage Change in Quantity Supplied / Percentage Change in Price).
Resource Allocation Methods
Market price, command, majority rule, contest, first come first served, lottery, personal characteristics, and force.
Def of Market Price as Allocation Method
When a market price allocates a scarce resource, the people who are willing and able to pay the price get the resource. Does not work well for the poor who cannot afford school and doctor fees; these are usually allocated differently.
Def of Command System as Allocation Method
Allocation of resources by order of someone in authority, like the U.S. government. Works well in organizations where lines of authority are clear and easy to monitor; works badly when the range of activities monitored are large and when it is easy to fool those in authority.
Def of Majority Rule as Allocation Method
Allocation of resources in the way that the majority of voters choose. Works well when the decisions being made affect large numbers of people but self-interest must be suppressed to use resources most effectively.
Def of Contest as Allocation Method
Allocates resources to a winner; this is a good method when the efforts of the competitors are difficult to monitor but motivates people to work hard for the reward. Only a few people will win but more people will work hard in order to try and attain it.
Def of First Come, First Served as Allocation Method
Allocates resources to those first in line. Casual restaurants usually do this. Works best when a scarce resource can serve just one user at a time and badly when many try to access it simultaneously.
Def of Lottery as Allocation Method
Used to allocate landing spots in airports. Work best when there is no effective way to distinguish among potential users of a scarce resource.
Def of Personal Characteristics as Allocation Method
People with the "right" characteristics get the resources. Bad when used on basis of race and gender.
Def of Force as Allocation Method
Self-explanatory; war, theft are obviously bad. he state can use force to allocate resources in the form of taxes and other aspects of the law.
A Demand Curve is...
A demand curve is a marginal benefit curve since willingness to pay determines demand.
Def of Market Demand Curve
The market demand is the horizontal sum of the individual demand curves and is formed by adding the quantities demanded by all the individuals at each price.
Def of Consumer Surplus
Consumer surplus is the excess amount of the benefit received from a good over the amount paid for it. you calculate consumer surplus as the marginal benefit (value) of a good minus its price, summed over the quantity bought. This is graphically represented by the above shape (usually a triangle) resulting from the intersection of individual/market demand curve and demand curve.
Def of Market Supply Curve
The market supply curve is the horizontal sum of the individual supply curves and is formed by adding the quantities supplied by all the producers at each price.
Def of Producer Surplus
PS is the excess of the amount received from the sale of a good or service over the cost of producing it. It is calculated as the price received minus the marginal cost (or minimum supply-price), summed over the quantity supplied. Graphically represented as the area below the intersection of the market demand curve and the market supply curve.
Def of Total Surplus
The sum of consumer surplus and producer surplus. When the efficient quantity is produced, total surplus is maximized.
Def of Market Failure
A situation in which a market delivers an ineffective outcome: underproduction and overproduction.
Def of Deadweight Loss
The decrease in total surplus that results from an inefficient level of production.
The Big Tradeoff is
The big tradeoff is a tradeoff between efficiency and fairness.
Results of a Price Ceiling/Price Cap
A price ceiling set above the equilibrium price has no effect since it does not constrain the market forces. However, if it is set below the equilibrium price, it can have powerful effects; it can result in a housing shortage, increased search activity, and a black market.
Def and Cause of Housing Shortage
Rent set below the equilibrium rent, the quantity of houses demanded exceeds the quantity of houses supplied causing a shortage. This can itself create increased search activity.
Def and Cause of Increased Search Activity
Time spent looking for someone with whom to do business. The cost of increased search activity might end up making the full cost of housing higher than it would be without a rent ceiling.
Def of Black Market
A black market forms when a price ceiling is set below the equilibrium price; in a black market, the price can be higher. People can pay for useless things in order to make it technically legal.
Why a Rent Ceiling is Inefficient
It is inefficient because the marginal social benefit of housing exceeds its marginal social cost and a deadweight loss shrinks its producer surplus
Why Minimum Wage Brings Unemployment
A wage floor set above the equilibrium wage creates an excess in the quantity of labor demanded creating unemployment. Unemployment can be calculated for a specific supply and demand curve with the minimum wage intersecting each; the distance between the intersections of the supply and demand curves is the unemployment figure for that graph.
Def of Tax Incidence
Tax incidence is the division of the burden of a tax between buyers and sellers.
Tax Incidence and Elasticity of Demand
When the demand is perfectly inelastic, the buyers pay. While if the demand is perfectly elastic, sellers pay.
Tax Incidence and Elasticity of Supply
When supply is perfectly inelastic, sellers pay. When supply is perfectly elastic, buyers pay.
Def of Production Quota
A production quota is an upper limit to the quantity of a good that may be produced in a specified period. Nothing happens when the production quota is set above the equilibrium price but when it is lower it causes problems!
Effects of a Quota Lower than Equilibrium Price
A decrease in supply, a rise in price, a decrease in marginal cost, inefficient underproduction, an incentive to cheat and overproduce.
Def and Effects of Subsidy
A subsidy is a payment made by the government to a producer. Effects include: increase in supply, a fall in price and increase in quantity produced, increase in marginal cost, payments by governments to farmers, inefficient overproduction.
Penalties on Sellers for Illegal Goods
Bring a decrease in supply, a leftward shift in the supply curve. To determine the new supply curve, we add the cost of breaking the law to the minimum price that drug dealers are willing to accept.
Penalties on Buyers for Illegal Goods
Decreases demand, shifting the demand curve leftward.
Penalties on Buyers and Sellers of Illegal Goods
Both the demand and supply curves shift leftward creating a new equilibrium price. When penalties are heavier on sellers, the supply curve shifts farther than the demand curve and the market price rises above the previous equilibrium price. If penalties are heavier on buyers, the demand curve shifts farther than the supply curve and the market price falls.
Def of Utility
The enjoyment or satisfaction people receive from consuming goods and services.
Def of Marginal Utility (MU)
The change in total utility a person receives from consuming one additional unit of a good or service.
The Law of Diminishing Marginal Utility
The principle that consumers experience diminishing additional satisfaction as they consume more of a good or service during a given period of time.
What is relationship between marginal benefit, value, and demand?
The value of one more unit of good is its marginal benefit; measured by the max amount consumers are willing to pay for one more unit. Demand curve shows max consumers are walling to pay so the curve is the same as a marginal benefit curve.
Two Main Approaches to Fairness
It's not fair if the results aren't fair (utilitarianism), and It's not fair if the rules aren't fair (equality of opportunity).
How does the elasticity of demand influence the incidence of a tax, the tax revenue, and the deadweight loss?
The more elastic the demand for a given supply, the smaller the increase in the price paid by the buyers and the greater the decrease in the price received by the sellers, which means that the incidence on buyers is smaller. Additionally, the more elastic the demand, the smaller the quantity bought to the smaller the tax revenue and the larger the deadweight loss.
How does elasticity of supply influence the incidence of a tax, the tax revenue, and the deadweight loss?
The more elastic the supply for a given demand, the larger the increase in the price paid by the buyers and the smaller the decrease in the price received by the sellers which means that the incidence on buyers is larger. Additionally, the more elastic the supply, the smaller the quantity bought so the smaller the tax revenue and the larger the deadweight loss.
Why is a tax inefficient?
The imposition of a tax on a market causes a wedge to be driven between the price received by the seller and the price paid by the buyer. This causes the marginal social benefit from the last unit sold to be higher than its marginal social cost, and the market will under-produce the good or service being taxed. If more of the good or service were produced, the marginal social benefit gained would be greater than the marginal social cost incurred, and the net benefit to society would increase.
When would a tax be efficient?
A tax is efficient, that is, creates no deadweight loss, when demand is perfectly inelastic or supply is perfectly inelastic. In both cases a tax does not change the quantity produced and so creates no deadweight loss.
Fairness Applied to the Tax System
Two principles are the benefits principle and the ability-to-pay principle.
Effects of Production Quota on Market Price and Quantity Produced
A production quota set below the equilibrium quantity raises the price and decreases the quantity. whatever [Show Less]