Economics Ch. 9

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Terms in this set (...)

What type of relationship exists between price and quantity demanded?
Inverse
Why does the law of demand occur?
The substitution effect and income effect
Describe the substitution effect
If the price increases for a product, consumers buy less of that product and more of another product for all goods
Describe the income effect
If the price decreases for a good, the purchasing power of consumers increases (they can purchase more). In effect, it increases available income. The opposite occurs if price increases
Does the a decrease in the price of a normal good increase or decrease purchases due to the income effect?
increases
Does the a decrease in the price of a inferior good increase or decrease purchases due to the income effect?
decreases
Does the a increase in the price of a normal good increase or decrease purchases due to the income effect?
decreases
Does the a increase in the price of a inferior good increase or decrease purchases due to the income effect?
increases
What does elasticity show?
How sensitive one variable is to a change in another variable
Price elasticity of demand
Measure of consumers' responsiveness to a change in price
Why is the price elasticity of demand important?
Firms se it to determine prices and sales and governments use it to decide how to tax.
What are the 4 types of elasticity?
Price elasticity of demand, price elasticity of supply, cross-price elasticity of demand, and income elasticity of demand
Percent change equation for price elasticity of demand
% change in quantity demanded/% change in price
% change in quantity
[(new quantity-old quantity)/old quantity]x100
% change in price
[(new price-old price)/old price]x100
For what type of elasticity should the negative sign be dropped?
Price elasticity of demand
Midpoint method for price elasticity of supply
See image
Pesto Pizza raises the price from $10 to $14. Within a week, sales of pizza go from 200 to 100. Calculate the price elasticity of demand using both methods.
1.25; 2
Broadwalk Ice Cream sells ice cream cones for $2.50. At that price, it sells 100 ice cream comes a day. When it lowers the price to $2.20, it sells 125 per day. Calculate the price elasticity of demand using both methods.
2.08; 1.74
When is demand elastic?
Price elasticity of demand is greater than 1
When is demand inelastic?
Price elasticity of demand is less than 1
When is demand unit elastic?
Price elasticity of demand equals 1
What 5 factors determine the price elasticity os demand?
Whether close substitutes are available, whether the good takes up a large portion of income, whether the good is a luxury or necessity, whether the good is habit forming, and time
A good is perfectly elastic when what?
An increase/decrease in price leaves quantity demanded unchanged.
A good is perfectly inelastic when what?
An increase/decrease in quantity demanded leaves price unchanged.
What does price elasticity of demand equal when the good is perfectly elastic?
0
What does price elasticity of demand equal when the good is perfectly inelastic?
infinity
What does total revenue equal?
price x quantity demanded
What happens to the total revenue for a good with a larger price effect than sales effect after a price increase?
It increases
What happens to the total revenue for a good with a larger sales effect than price effect after a price increase?
It decreases
Slope of a perfectly elastic good
horizontal line
Slope of a perfectly inelastic good
vertical line
For what type of good is the sales effect greater than the price effect? What does this mean?
elastic; an increase in price reduces total revenue
For what type of good is the price effect greater than the sales effect?
inelastic; an increase in price increases total revenue
For what type of good does the price effect equal the sales effect?
Unit elastic; an increase in price does not change total revenue
What does the price elasticity of supply show?
How sensitive producers are to a change in price.
What is the price elasticity of supply based on?
Time limitations and availability of inputs
Percent change equation for price elasticity of supply
% change in quantity supplied/% change in price
Most goods are ____ in the short-run and ___ in the long run. (price elasticity of supply)
inelastic; elastic
What does the cross-price elasticity of demand show?
How sensitive a product is to a change in price of another good
Equation for cross-price elasticity of demand
% change in quantity demanded of product b/% change in price of product a
Is cross-price elasticity of demand positive or negative for complements?
Negative
Is cross-price elasticity of demand positive or negative for substitutes?
Positive
The price of Nike shoes increases by 2% and the quantity demanded for Converse shoes increases by 4%. Find cross-price elasticity of demand. Are the complements of substitutes?
2; substitutes
What does income elasticity of demand show?
How sensitive a product is to a change in income.
Equation for income elasticity of demand
% change in quantity demanded/% change in income
Is income elasticity of demand positive or negative for inferior goods?
negative
Is income elasticity of demand positive or negative for normal goods?
positive
American consumer income rises by 4% and the quantity of fresh vegetables purchased increases by 1%. What is the income elasticity of demand? Are vegetables normal or inferior?
0.25; normal
There are other close substitutes. More elastic or inelastic?
More elastic
There are no close substitutes. More elastic or inelastic?
More inelastic
The good is a necessity. More elastic or inelastic?
More inelastic
The good is a luxury. More elastic or inelastic?
More elastic
Spending on the good accounts for a small portion of income. More elastic or inelastic?
More inelastic
Spending on the good accounts for a large portion of income. More elastic or inelastic?
More elastic
Consumers have time to adjust to a change in price. More elastic or inelastic?
More elastic
Consumers have no time to adjust to a change in price. More elastic or inelastic?
More inelastic
The good is addictive or habit forming. More elastic or inelastic?
More inelastic
Individual consumer surplus
the net gain to an individual buyer from the purchase of a good that is equal to the difference between the buyer's willingness to pay and the price paid
total consumer surplus
the sum of the individual consumer surpluses of all the buyers of a good
Consumer surplus is the area on a graph between the ____ and the ____ curve.
price; demand
What us a potential seller's cost?
The lowest price at which he or she is willing to sell a good
individual producer surplus
the net gain to a seller from selling a good that is equal to the difference between the price received and the sellers cost
total producer surplus
the sum of the individual producer surpluses of all the sellers of a good
Producer surplus is the area on a graph between the ____ and the ____ curve.
price; supply
Why does the market equilibrium maximize total surplus?
The market allocates consumption of the good to the potential buyers who value it the most, allocates sales to the potential sellers who most value the right to sell the good, ensures that every consumer who makes a purchase values the good more than every seller who makes a sale, and ensures that every potential buyer who doesn't make a purchase values the good less than every potential seller who doesn't make a sale
What must a market do to be efficient?
Maximize consumer and producer surplus
What does a tax cause to society and why?
A deadweight loss; less of the good is produced and consumed than in the absence of the tax and as a result, some mutually beneficial trades between producers and consumers do not take place
What happens to the supply curve if there is an excise tax of $2?
It shifts upward by the amount of the tax
Other things equal, you want to chose the policy that produces the ____ deadweight loss.
smallest
How does one predict the deadweight loss of a given policy?
When demand or supply, or both, is inelastic, there will be a relatively small decrease in quantity transacted and a small deadweight loss
Who does the tax burden fall on for an excise tax paid mainly by consumers?
Consumers
Who does the tax burden fall on for an excise tax paid mainly by producers?
Producers
Consumers should continue to consume until what equals what?
Marginal benefit equals marginal cost
A consumer's willingness to pay for a good is the ____ ____ at which he or she would buy that good.
maximum price
total surplus
the total net gain to consumers and producers from trading in a market; the sum of producer and consumer surplus
progressive tax
a tax that rises more in proportion to income
regressive tax
tax that rises less in proportion to income
excise tax
tax on sales of a particular good or service
tax incidence
distribution of the tax burden
deadweight loss from a tax
the decrease in total surplus resulting from the tax, minus the tax revenues generates
administrative costs
the resources used by the govt. to collect the tax, and by taxpayers to pay (or to evade) it, over and above the amount collected
lump-sum tax
a tax of a fixed amount paid by all taxpayers
utility
measure of personal satisfaction
marginal utility
the change in total utility generated by consuming one additional unit of that good or service
What does the marginal utility curve show?
How marginal utility depends on the quantity of a good or service consumed
What does the principle of diminishing marginal utility say?
Each successive unit of a good or service consumed adds less to total utility than does the previous unit
What does the budget constant limit?
The cost of a consumer's consumption bundle to no more than the consumer's income
consumption possibilities
the set of all consumption bundles that are affordable, given the consumer's income and prevailing prices
What does a consumer's budget line show?
The consumption bundles available to a consumer who spends all of his or her income
What is a consumer's optimal consumption bundle?
The consumption bundle that maximizes the consumer's total utility given his or her budget constraint
marginal utility per dollar spent
The additional utility from spending one more dollar on a good or service
Optimal consumption rule
When a consumer maximizes utility in the face of a budget constraint, the marginal utility per dollar spent on each good or service in the consumption bundle is the same (MUc/Pc=MUp/Pp)