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: Other things being equal, when the price of a good rises,
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is a measure of how much buyers and sellers respond to changes in market conditions. When studying how some event or policy affects a market, we can discuss not only the direction of the effects but also their magnitude.
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Chapter 5
Micro book notes
| Question | Answer |
|---|---|
| : Other things being equal, when the price of a good rises, | the quantity demanded falls |
| is a measure of how much buyers and sellers respond to changes in market conditions. When studying how some event or policy affects a market, we can discuss not only the direction of the effects but also their magnitude. | Elasticity |
| e quantity demanded responds more | than it does in the short run. |
| A 10 percent increase in gaso-line prices reduces gasoline consumption by about 2.5 percent after a year and by about 6 percent after five years. About half of the long-run reduction in quantity demanded arises because | people drive less, and half arises because they switch to more fuel-efficient cars. Both responses are reflected in the demand curve and its elasticity |
| 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 | price elasticity of demand |
| The price elasticity of demand for any good measures | how willing consumers are to buy less of the good as its price rises. |
| A good with close substitutes tends to have more elastic demand because it is easier for consumers to switch from that good to others. F | Availability of Close Substitutes |
| For example, butter and margarine are easily substitutable. | A small increase in the price of butter, assuming the price of margarine is held fixed, causes the quantity of butter sold to fall by a large amount. By contrast, because eggs are a food without a close substitute, the demand for eggs is less elastic tha |
| Necessities tend to have inelastic demands, whereas luxuries have elastic demands. | Necessities versus Luxuries |
| . When the price of a doctor’s visit rises, | people do not dramatically reduce the number of times they go to the doctor, although they might go somewhat less often. By contrast, when the price of sailboats rises, the quantity of sailboats demanded falls substantially. The reason is that most peopl |
| markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. | Definition of the Market |
| has a more elastic demand because it is easy to substitute other desserts for ice cream. Vanilla ice cream, an even narrower category, has a very elastic demand because other flavors of ice cream are almost perfect substi-tutes for vanilla. | Definition of the market example food, a broad category, has a fairly inelastic demand because there are no good substitutes for food. Ice cream, a narrow category |
| Goods tend to have more elastic demand over longer time hori-zons. When the price of gasoline rises, the quantity of gasoline demanded falls only slightly in the first few months. Over time, however, people buy more fuel-efficient cars, switch to public | Time Horizon |
| . Economists compute the price elastic-ity of demand | as the percentage change in the quantity demanded divided by the percentage change in the price. |
| percentage change in quantity will always | have the opposite sign as the percent-age change in price. |
| , price elasticities of demand are sometimes reported as | negative numbers |
| we follow the common practice of dropping the minus sign and reporting all price elasticities of demand as | Positive numbers |
| all percentage changes are calculated using the | midpoint method |
| When demand is inelastic ________ price and total revenue move in the same direction: If the price increases, total revenue also increases | a price elasticity less than one |
| When demand is elastic________ price and total revenue move in opposite directions: If the price increases, total revenue decreases | a price elasticity greater than one |
| If demand is unit elastic ________ total revenue remains constant when the price changes | (a price elasticity exactly equal to one) |
| . The standard procedure for computing a percentage change is to | divide the change by the initial level. |
| Demand is considered _______ when the elasticity is greater than one, which means the quantity moves proportionately more than the price | elastic |
| Demand is considered ________ when the elasticity is less than one, which means the quantity moves proportionately less than the price. | inelastic |
| If the elasticity is exactly one | the percentage change in quantity equals the percentage change in price, and demand is said to have unit elasticity. Because the price elasticity of demand measures how much quantity demanded responds to changes in the price, it is closely related to th |
| the greater the price elasticity of demand | The steeper the demand curve passing through a given point, the smaller the price elasticity of demand. |
| f you have trouble keeping straight the terms elastic and inelastic, here’s a memory trick for you: | Inelastic curves, such as in panel (a) of Figure 1, look like the letter I. This is not a deep insight, but it might help on your next exam. |
| When studying changes in supply or demand in a market, one variable we often want to study is | 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 | total revenue definition |
| In any market, total revenue is | P x Q, the price of the good times the quantity of the good sold. |
| : An increase in the price cause | a decrease in total revenue |
| . Because demand is elastic | the reduction in the quantity demanded is so great that it more than offsets the increase in the price. That is, an increase in price reduces P 3 Q because the fall in Q is proportionately greater than the rise in P. |
| the impact of a price change on total revenue (the product of price and quantity) depends on | the elasticity of demand. |
| a straight line has a | constant slope |
| Slope is defined as | rise / run ” which here is the ratio of the change in price (“rise”) to the change in quantity (“run”). |
| e the slope is the ratio of changes in the | two variables |
| the slope of a linear demand curve is constant, but its elasticity is | not |
| the price elasticity of demand is calculated using | the demand schedule in the table and the midpoint method. |
| At points with a low price and high quantity, the demand curve is | inelastic |
| At points with a high price and low quantity, the demand curve is | elastic |
| the elasticity is | the ratio of percentage changes in the two variables |
| At points with a low price and high quantity, | the demand curve is inelastic |
| At points with a high price and low quantity, | the demand curve is elastic |
| When the price is low and consumers are buying a lot | a $1 price increase and two-unit reduction in quantity demanded constitute a large percentage increase in the price and a small percentage decrease in quantity demanded, resulting in a small elasticity |
| When the price is high and consumers are not buying much | the same $1 price increase and two-unit reduction in quantity demanded constitute a small percentage increase in the price and a large percentage decrease in quantity demanded, resulting in a large elasticity |
| When the price is $1, | for instance, demand is inelastic and a price increase to $2 raises total revenue. |
| When the price is $5, demand is elastic and a price increase to $6 | reduces total revenue. |
| . Between $3 and $4, demand is | exactly unit elastic and total revenue is the same at these two prices. |
| A constant elasticity is possible, | , but it is not always the case, and it is never the case for a linear demand curve. |
| 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 | income elasticity of demand |
| Higher income raises the quantity demanded Because quantity demanded and income move in the same direction, normal goods have positive income elasticities. | normal goods |
| Higher income lowers the quantity demanded. Because quantity demanded and income move in opposite directions, inferior goods have negative income elasticities | inferior goods |
| As a family’s income rises, the percent of its income spent on food declines, indicating an income elasticity less than one By contrast, luxuries such as jewelry and recreational goods tend to have large income elasticities because consumers feel that t | Engel’s Law (named after the statistician who discovered it): |
| measures how the quantity demanded of one good responds to a change in the price of another good. It is calculated as the percentage change in quantity demanded of good one divided by the percentage change in the price of good two | The cross-price elasticity of demand |
| Whether the cross-price elasticity is positive or negative depends on whether | the two goods are substitutes or complements |
| are goods that are typically used in place of one another, such as ham-burgers and hot dogs | substitutes |
| An increase in hot dog prices induces people to grill more hamburgers instead. | Because the price of hot dogs and the quantity of hamburg-ers demanded move in the same direction, the cross-price elasticity is positive |
| goods that are typically used together, such as computers and software. In this case, the cross-price elasticity is negative, indicating that an increase in the price of computers reduces the quantity of software demanded | , complements are |
| 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 | . The price elasticity of supply |
| The price elasticity of supply depends on | the flexibility of sellers to change the amount of the good they produce. For example, beachfront land has an inelastic supply because it is almost impossible to produce more of it. |
| Manufactured goods, such as books, cars, and televisions, have | elastic supplies because firms that produce them can run their factories longer in response to higher prices. |
| In most markets, a key determinant of the price elasticity of supply is the | me period being considered. Supply is usually more elastic in the long run than in the short run. |
| Over short periods of time, firms cannot | easily change the size of their factories to make more or less of a good. Thus, in the short run, the quantity sup-plied is not very responsive to changes in the price. |
| As the elasticity rises, | the supply curve gets flatter, which shows that the quantity supplied responds more to changes in the price |
| , supply is | perfectly elastic This occurs as the price elasticity of supply approaches infinity and the sup-ply curve becomes horizontal, meaning that very small changes in the price lead to very large changes in the quantity supplied. |
| In some markets, the elasticity of supply is | not constant but varies over the sup-ply curve. |
| For low levels of quantity supplied, the elasticity of supply is | high, indicating that firms respond substantially to changes in the price. In this region of the supply curve, firms have additional capacity for production, such as plants and equipment that are idle for all or part of the day |
| y. As the quantity supplied rises, | firms begin to reach capacity. Once capacity is fully used, further increases in production require the construction of new plants. To induce firms to incur this extra expense, the price must rise substantially, so supply becomes less elastic. |
| Because firms often have a maximum capacity for production, | the elasticity of supply may be very high at low levels of quantity supplied and very low at high levels of quantity supplied. |
| The price elasticity of demand determines whether | total revenue rises or falls |
| s. When the demand curve is inelastic, | a decrease in price causes total revenue to fall. |
| This analysis of the market for farm products also explains a seeming paradox of public policy | Certain farm programs try to help farmers by inducing them not to plant crops on all of their land. The purpose of these programs is to reduce the supply of farm products and thereby raise prices |
| . With inelastic demand for their products, | farmers as a group receive greater total revenue if they supply a smaller crop to the market. |
| The OPEC episodes of the 1970s and 1980s show | how supply and demand can behave differently in the short run and in the long run |
| In the short run | both the supply and demand for oil are relatively inelastic. Supply is inelastic because the quantity of known oil reserves and the capacity for oil extraction cannot be changed quickly |
| demand is | inelastic because buying habits do not respond immediately to changes in price |
| producers of oil outside OPEC respond to high prices by | increasing oil exploration and by building new extraction capacity. Consumers respond with greater conser-vation, such as by replacing old inefficient cars with newer efficient ones. |
| in competitive markets, farmers adopt new technologies that will eventually reduce their revenue because | each farmer is a price taker. |
| Because the demand curve for oil is ________ elastic in the long run, OPEC's reduction in the supply of oil had a ________ impact on the price in the long run than it did in the short run | more, smaller |
| over time, technological advances increase consumers’ incomes and reduce the price of smartphones. | Each of these forces increases the amount consumers spend on smartphones if the income elasticity of demand is greater than _________ and the price elasticity of demand is greater than _________ |
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