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Microeconomics: Mankiw Chapter 5
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Terms in this set (32)
Elasticity
a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of its determinants. Something is said to be elastic if the quantity demanded responds substantially to the changes in price. Demand is said to be inelastic if the quantity demanded responds only slightly to changes in price.
Price elasticity of demand
a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price
Things that influence the the price elasticity of demand
Availability of close substitutes, Necessities versus luxuries, Definition of the market, Time horizon
What the availibility of close substitutes does
Goods with these tend to have more elastic demand because it is easier for consumers to switch from that good to others. Ex. Butter vs. Eggs butter is more elastic b/c an increase in its price would lead to a much larger change in demand because it has a close substitute of margarine. Eggs do not have a close substitute so a change in the price of eggs would not significantly change the amount eggs demanded so it is less elastic.
Necessities versus Luxuries
Necessities tend to have inelastic demands, luxuries tend to have more elastic demand. However, whether a good is a luxury or not really depends on the preferences of the buyer.
Definition of the market
More broadly defined markets will be less elastic than narrow markets. Food is a necessity and thus inelastic, but ice cream ( a narrowly defined market) is more elastic b/c there are other dessert substitutes
Time Horizon
Goods tend to have more elastic demand over longer time horizons. Ex. gas prices rise- quantity demanded only falls slightly in the first few months but over time people buy more fuel efficient cars, switch to public transport, ect so over time demand falls more.
Equation for the price elasticity of demand :
Percentage change in the quantity demanded / Percentage change in price
The percentage change in in quantity will always?
Have the opposite sign as the percentage change in price. This is because the quantity demanded of a good is negatively related to its price.
The midpoint method
To calculate the percentage change in price using the midpoint method, we divide the change in the price by the average price—the average of the new price and the initial price—and then multiply by 100. The average price is at the midpoint between the initial and the new price, hence the name midpoint method. Used when calculating the price elasticity of demand between two points .
Midpoint method formula
( Q2-Q1)/[ Q2+Q1)/2] / ( P2-P1)/ [(P2+P1)/2]
When is demand considered elastic?
When the elasticity is greater than 1 meaning that the quantity moves proportionately more than the price
When is demand considered inelastic?
When the elasticity is less than one, meaning that the quantity moves proportionately less than the price
What is unit elasticity?
If the elasticity is exactly 1, meaning that the percentage change in in quantity equals the percentage change in price
The flatter the demand curve that passes through a given point... ?
The greater the price elasticity of demand
The steeper the demand curve that passes through a given point... ?
The smaller the price elasticity of demand
Zero Elasticity
Total Revenue
the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold ( PxQ)
If demand is inelastic then an increase in the price causes ____________ in total revenue?
an increase
If demand is elastic then an increase in the prices causes _____________ in total revenue?
a decrease
When demand is inelastic
then price and total revenue move in the same direction. If the price increases, total revenue also increases
When demand is elastic
price and total revenue move in opposite directions ; if the price increases , total revenue decreases
If demand is unit elastic
Total revenue remains constant when the price changes
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
= (Percentage change in quantity demanded)/ (Percentage change in income)
Inferior goods have..?
Negative income elasticities. The demand for them decline as income rises.
The 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 in change in quantity demanded of the first good divided by the percentage change in price of the second good. Depends on whether the goods are substitutes of complements
= (Percentage Change in quantity demanded of good 1)/(percentage change in the price of good 2)
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. Supply of a good is said to be elastic if the quantity supplied responds substantially to a change in price . Depends on the flexibility of sellers to change the amount of the good they produce. Ex. Beachfront land has an inelastic supply because it is almost impossible to produce more of it,.
Key determinant of the price elasticity of of supply :
The time period being considered.
Supply is usually more elastic in the ____ run
long. Firms have more time to do things like open more factories. So quantity supplied can respond substantially to price changes in the long run
Formula for the Price Elasticity of supply
( Percentage change in quantity supplied) / ( Percentage change in price)
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
Formula for the income elasticity of demand =
(percentage change in quantity demanded)/ (percentage change in income)
;