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ECON 2302 Test 1

PRICE ELASTICITY OF DEMAND

Ed=%∆Qd%∆P

The Midpoint Formula

Ed=∆QdSum of Quantites/2∆PSum of Prices/2

Elastic >1
Inelastic <1
Perfectly elastic ∞
Perfectly inelastic ∞

The Midpoint Forumula - P↑ $6 to $9


Q↓200 to 100 =10015037.5=.66.4=1.65
Demand is elastic

P↓$16 to $12
Q↑400 to 440 =40420414=.09.29=.31
Demand is inelastic

Total Revenue (TR) =Price times Quantity

Elastic- P↑TR↓
P↓TR↑

Inelastic - P↑TR↑
P↓TR↓

-When demand is elastic a change in price will cause TR to do the opposite


-When demand is inelastic a change in price will cause TR to the same
Determinants of Elasticity of Demand
1. Number of Substitutions – larger number of good substitutions a good has,
the larger the elasticity of demand; fewer number of good substitutions the
more inelastic the demand
2. Proportion of Income – the larger proportion of income it takes to purchase a
good, the greater the elasticity of demand; the smaller proportion of income
the more inelastic
3. Luxuries vs. Necessities – Luxuries are elastic, necessities are inelastic
4. Time – Over time demand becomes more elastic; demand is more elastic in
the long run than the short run

Cross Elasticity of Demand

Test to see if goods X and Y are substitute or complimentary goods (p. 124)

Pepsi Film

P↑ Coke P↑ Cameras
P↓ Coke P↓ Cameras

Exy=%∆Qd of good x%∆P of good y

If Exy is positive, goods x and y are substitutes


If Exy is negative, goods x and y are complimentary
Elasticity of Supply

-Measures producers responsiveness to changes in price

Es=%∆Qs%∆P elastic >1


Inelastic <1
Unit elastic =1
Perfectly elastic ∞
Perfectly inelastic (ex: perishable agricultural products)
Producers: Larger coefficient, more responsive
Smaller coefficient, less responsive

-The supply becomes more elastic over time. Time is the only determinant of
elasticity of supply. (The more time a producer has, the greater the resource
shiftability.)

*The flatter a Supply or Demand curve, the more elastic


*The steeper a supply or Demand curve, the more inelastic

Immediate Market Period Short Run Period Long Run Period

EP↑ EP↑ EP↑


EQ same EQ↑ EQ↑

*Greater time means a greater opportunity to expand output

Income Elasticity of Demand


-A test to see if a good is a normal good or an inferior good

Normal good - a change in income will change the demand curve the same way
Ex: Steak

Income↑ Income↓

Inferior Good – a change in income will change demand curve the opposite way
Ex: Beans
Income ↑ Income↓

Ei=%∆Qd%∆Income

-if Ei is positive, the good is a normal good -- or ++

-if Ei is negative, the good is and inferior good +- or -+

Consumer and Producer Surplus


Consumer Surplus – The difference between the maximum price a consumer is
willing to pay and market price
Producer Surplus – The difference between the minimum price a producer is willing
to receive and what they actually receive

Consumer Habits

Utility – satisfaction derived from consuming goods and services


Marginal Utility (MU) – additional utility one receives from consuming one more unit
of a good (=∆TU∆Q)

*Law of Diminishing Marginal Utility(p.136) – successive units of any good


consumed will yield less and less additional satisfaction (the more you have of
something, the less you value additional units)

Assumptions – rational behavior, preferences, prices of goods must be provided

The following must be provided to do Marginal Analysis(p.138):


-Income
-Marginal Utilities of goods A and B
- Price of goods A and B
Utility Maximizing Rule – When the MUaPa=MUbPb and all income is spent, the
consumer is at equilibrium.
Decision Rules: (*pp.137-140 top
paragraph)
-if MUaPa>MUbPb , the consumer should purchase more A
-if MUaPa<MUbPb , the consumer should purchase more B

EX:
Units of Product MUa MUaPa MUb MUbPb

I = $10 1 10 10 24 12
Pa=$1.00 2 8 8 20 10
Pb=$2.00 3 7 7 18 9
4 6 6 16 8
5 5 5 12 6
6 4 4 6 3
7 3 3 4 2

Consumer equilibrium is 4 units of B and 2 units of A


Total Utility = 10+8 + 24+20+18+16 = 96 utils (measurement of utility)
(From A) (From B)

Indifference Curve Analysis


-to conduct indifference analysis, the following must be provided:
Income
Price of goods A and B
Indifference curves must be provided

Budget Line (constraint) – shows us what is attainable for the consumer to buy,
when we know income and price of good A and B
-Income changes, curve shifts
-Price changes, curve takes on a new slope
EX (Budget Curve):
Income = $12
Price of goods = A-$1.50 B-$1.00
Indifference Curve – shows the various combinations of goods A and B that will
provide equal satisfaction or total utility for the consumer

Marginal Rate of Substitution(MRS) – slope of Indifference Curve, tells us how many


units of A must be given up to get more B and remain equally satisfied

Characteristics of Indifference Curves:


1. Downward sloping
2. Indifference map
3. Preference direction – indifference curves will never intersect and any
Indifference Curve to the right is preferable
Consumer Equilibrium – occurs where the highest Indifference Curve is at a point of
tangency to the budget line

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