Chapter 4 and 5: Elasticity and Efficiency
Chapter 4 and 5: Elasticity and Efficiency 2001.01
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Alyce Kunde Jr.
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This 8 page Class Notes was uploaded by annehohler on Friday September 18, 2015. The Class Notes belongs to 2001.01 at Ohio State University taught by Dr. Ida Mirzaie in Summer 2015. Since its upload, it has received 297 views. For similar materials see Microeconomics in Economcs at Ohio State University.
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Date Created: 09/18/15
MICROEOONOMICS ELASTlClTY AND EFFICIENCY Chapter 4 Elasticity Elasticity measure of how much supply and demand will respond to changes in price and income market conditions DEMAND Price Elasticity of Demand how much the quantity demanded of a good or service changes with price change Basically how sensitive customers are to price change 39 ALWAYS NEGATIVE so we use the absolute value of the number X found I X I The formula uses the midpoint method which measures the percentage change relationship to a point midway between the two points It makes the percentage of change constant from an increase to decrease or decrease to increase This formula is in bold below Chamgc m Quanfify Q2 Q1 2 Forkruler Chamgc m Price P2 P7PZ P1 2 le It helps to put terms into ordered pairs P1 Q1 and P2 Q2 to keep the numbers straight before plugging them into the formula If the number found X is GREATER than 1 it is elastic VERY responsive to price change If the number found X is LESS than 1 it is inelastic NOT responsive to price change If the number found X is EQUAL to 1 it is unit elastic This is because the SMALLER the change the LESS NOTICEABLE it is inelastic Likewise the BIGGER the change the MORE NOTICEABLE it is elastic MICROEOONOMICS ELASTICITY AND EFFICIENCY 2 Perfect elasticity occurs when the demand curve is HORIZONTAL this is so demand can be any price but will drop to zero if the price increases Perfect inelasticity occurs when the demand curve is VERTICAL the quantity demanded is always the same no matter the price Total revenue is the amount that a rm receives from the sale of a good or service calculated as the quantity sold multiplied by the price paid for each unit basically how much money sellers get by selling ForkMia 2 Q x V Per unit An increase in price affects the total revenue one of two ways 1 By causing a quantity effect where there s a decrease in revenue from selling fewer units of the good service 2 Or by causing a price effect where there s an increase in revenue from a higher price for each unit sold Normally an elastic demand is from a price increase which causes a decrease in total revenue and thus a decrease in demand Demand tends to be more elastic when price is high and more inelastic when price is low Tidbit Price change affects adults LESS than youth because youth have LIMITED FUNDS Determinants of Price Elasticity of Demand 1 Availability of substitutes 2 Degree of necessity 3 Cost relative to income MICROEOONOMICS ELASTlClTY AND EFFICIENCY 4 Adjustment time long run or short run 5 Scope of the market CrossPrice Elasticity of Demand What happens to quantity demanded of one good When another changes Answers How Will other s respond Change in Quanfn g Denlanded of Producf A QaZ Qa lQa2 Qa l Z FornAula Change in Price of Producf B PhZ Ph7Ph2 PM 2 substitutes have a positive crossprice elasticity the closer the substitute the larger the elasticity complements have a negative crossprice elasticity again the closer the complement the larger the elasticity Income Elasticity of Demand how much the quantity demanded of a good service changes in response to a change in consumer s incomes Change in Quaang Dennanoleol of Producf A QaZ Qa lQa2 Qa l Z FornAula Change in Price of Producf B PhZ Ph lPh2 PM 2 normal goods have positive income elasticity remember increase income increase demand has larger elasticity if it has a close substitute example plain coffee and a frapp from Starbucks inferior goods have negative income elasticity remember increase income decrease demand MICROEOONOMICS ELASTlClTY AND EFFICIENCY however it is elastic when it s a unique necessary item eX an original piece of art SUPPLY Price Elasticitv of Supply the size of the change in quantity supplied of a good or service when its price changes Basically a measure of a producer s responsiveness to change in price and how much the quantity supplied changes ANSWER IS ALWAYS POSITIVE Change I M Quantity Q2 CooQz Q 2 FOYVVHAQI Change in Price P2 P1PZ P1 2 Same formula as Price Elasticity of Demand but now with the numbers for Supply Again If the number found X is GREATER than 1 it is elastic VERY responsive to price change If the number found X is LESS than 1 it is inelastic NOT responsive to price change If the number found X is EQUAL to 1 it is unit elastic Perfectly elastic if a quantity supplied can be anything at a given price and zero at any other price Perfectly inelastic if a quantity supplied is the same regardless of price Look familiar That s because it s the same guidelines as demand MICROEOONOMICS ELASTICITY AND EFFICIENCY 5 Determinants of Price Elasticity of Supply 1 Availability of inputs needs very high prices for change to happen 2 Flexibility of production process 3 Adjustment time more elastic long period of time 1 numbers are xed Within short intervals of time because change requires time cannot be instant With supply Applications of Elasticity of Supply 1 Antiques inelastic supply 2 Reproductions more elastic 3 Volatile gold prices inelastic supply MICROEOONOMICS ELASTICITY AND EFFICIENCY 6 Chapter 5 Ef ciency Ef ciency when the market equilibrium is a winwin situation both consumer and producer are receiving gains either in pro t or savings 7 I Answers How much to elasticity s How Voluntary exchanges create value and can make everyone involved better off Reservation price Willingness to Pay the maximum price someone will spend on an item point when a buyer says Forget it I ll go somewhere else At price above the willingness to pay the Opportunity Cost outweighs the bene ts Willingness to Sell minimum price that a seller is willing to accept as payment for a product they re selling determined by trade offs Surplus in a market a way of measuring who bene ts from transactions and by how much The bonus value of a good sale when you were willing to buy the product at full price Consumer Surplus the net bene t that a consumer receives from purchasing a good or service measured by the difference between willingness to pay and the actual price consumer surplus increases when price decreases inverse relationship when price increases less is bought decreasing consumer surplus Formwla amoum willing f0 Pay acfual Price MICROEOONOMICS ELASTICITY AND EFFICIENCY 7 Producer Surplus net bene t that a producer gets from the sale of a good service measured by the different between the producers Willingness to sell and actual price can be direct or secondhand think eBay When prices increase producer surplus increases Formwia amoum willing f0 5J2 acfuai Price Total Surplus measure of combined bene ts that everyone receives from participating in an exchange of goods services basically the value created by the existence of the market CANNOT BE LESS THAN ZERO The equilibrium in a perfect competitive wellfunctioning market maximizes total surplus Zerosum Game a situation Where Whenever one person gains another person loses in equal amount the net value of any transaction is zero example Poker A price below the market equilibrium Will ALWAYS reduce the producer surplus it Will either increase or decrease consumer surplus Deadweight loss loss of total surplus that occurs because the quantity of a good that is bought and sold is BELOW the market equilibrium quantity caused by an intervention MICROECONOMICS ELASTICITY AND EFFICIENCY 8 Formwia fofai SMYPiMS differ a Warsz meaeratrfiom surpius af Way39sz Q uiiibrium before meaeramfiotr Price 600 500 400 Deadweight loss 8 300 200 ansactions t I a a aggsrqhe 100 new price D l l l l l 0 510152025303540455055606 Quantity of cameras millions example from presentation Price change is an indirect cause of deadweight loss The direct cause is reduction in quantity of a product on the market to trade
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