Econ Exam 2

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Elasticity of Supply

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Responsiveness of producers to change in the price of their goods or services. As a general rule, if prices rise, so does the supply.

Elasticity of supply is measured as the ratio of proportionate change in the quantity supplied to the proportionate change in price. High elasticity indicates the supply is sensitive to change in prices, low elasticity indicates little sensitivity to price changes, and no elasticity means no relationship with price.

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Price elasticity of demand

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how sensitive is the quantity demanded to a change in the price of the good.

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Price elasticity of supply

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how sensitive is the quantity supplied to a change in the price of the good.

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When an elasticity is small (between 0 and 1 in absolute value)

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we call the relation that it describes inelastic. Inelastic demand means that the quantity demanded is not very sensitive to the price. Inelastic supply means that the quantity supplied is not very sensitive to the price.

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When an elasticity is large (greater than 1 in absolute value)

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we call the relation that it describes elastic. Elastic demand means that the quantity demanded is sensitive to the price. Elastic supply means that the quantity supplied is sensitive to the price.

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Extreme Price Elasticities

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"Perfectly elastic” and “perfectly inelastic”

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Perfectly elastic

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the quantity (demanded or supplied) is as price sensitive as possible.

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Perfectly inelastic

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the quantity (demanded or supplied) has no price sensitivity at all.

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Coefficient of elasticity

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measure of the relative response of one variable to changes in another variable. The coefficient of elasticity is used to quantify the concept of elasticity, including price elasticity of supply/demand, income elasticity of demand, and cross elasticity of demand. The coefficient can be calculated using the simple endpoint or midpoint formulas.

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Income Elasticity of Demand

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Relative response of demand to changes in income, or the percentage change in demand due to a percentage change in income. This elasticity quantifies the buyers' income demand determinant.

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Normal Good

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A good for which an increase in income causes an increase in demand, or a rightward shift in the demand curve. If demand increases as income increases, it is a normal good or a good with a positive income elasticity of demand.

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Inferior Good

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A good for which an increase in income causes a decrease in demand, or a leftward shift in the demand curve. If demand decreases as income increases, it is an inferior good, or a good with a negative income elasticity of demand.

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Complementary good

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A good with a negative cross elasticity of demand, in contrast to a substitute good. This means a good's demand is increased when the price of another good is decreased. Conversely, the demand for a good is decreased when the price of another good is increased.

If goods A and B are complements, an increase in the price of A will result in a leftward movement along the demand curve of A and cause the demand curve for B to shift in; less of each good will be demanded. A decrease in price of A will result in a rightward movement along the demand curve of A and cause the demand curve B to shift outward; more of each good will be demanded.

NEGATIVE COEFFICIENT INDICATES COMPLIMENTARY GOOD.

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Substitute Good

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Different goods that, at least partly, satisfy the same needs of the consumers and, therefore, can be used to replace one another. Price of such goods shows positive cross-elasticity of demand. Thus, if the price of one good goes up the sales of the other rise, and vice versa. Also called substitutes.

POSITIVE XED COEFFICIENT INDICATES SUBSTITUTE GOOD.

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Marginal Benefit

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The additional satisfaction or utility that a person receives from consuming an additional unit of a good or service. A person's marginal benefit is the maximum amount they are willing to pay to consume that additional unit of a good or service. In a normal situation, the marginal benefit will decrease as consumption increases.

(I.E. a consumer wishes to purchase an additional burger. If this consumer is willing to pay $10 for that additional burger, then the marginal benefit of consuming that burger is $10. The more burgers the consumer has, the less he or she will want to pay for the next one. This is because the benefit decreases as the quantity consumed increases.)

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Price Ceiling

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The maximum price a seller is allowed to charge for a product or service. Price ceilings are usually set by law and limit the seller pricing system to ensure fair and reasonable business practices. Price ceilings are usually set for essential expenses; for example, some areas have "rent ceilings" to protect renters from climbing rent prices. -Price ceilings are regulations designed to protect low income individuals from not being able to afford important resources. However, many economists question their effectiveness for several reasons. For example, price ceilings will have no effect if the equilibrium price of the good is below the ceiling (inefficient price ceiling).

If the ceiling is set below the equilibrium level, however, then there is a deadweight loss created. Other problems come in the form of black markets, search time, and fees, which are added but not directly associated with the sale - for example a high charge for fittings could be added to a maxed out rental cost.

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Deadweight Loss

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The costs to society created by market inefficiency. Can be applied to any deficiency caused by an inefficient allocation of resources. Price ceilings (such as price controls and rent controls), price floors (such as minimum wage and living wage laws) and taxation are all said to create deadweight losses. Deadweight loss occurs when supply and demand are not in equilibrium.

Price ceilings and rent controls can create deadweight losses by discouraging production and decreasing the supply of goods, services or housing below what consumers truly demand. Consumers experience shortages and producers earn less than they would otherwise. Taxes are also said to create a deadweight loss because they prevent people from engaging in purchases they would otherwise make because the final price of the product will be above the equilibrium market price.

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Price Floor

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A price floor is the lowest legal price a commodity can be sold at. Price floors are used by the government to prevent prices from being too low. The most common price floor is the minimum wage--the minimum price that can be payed for labor.

Price floors are also used often in agriculture to try to protect farmers. For a price floor to be effective, it must be set above the equilibrium price. If it's not above equilibrium, then the market won't sell below equilibrium and the price floor will be irrelevant. There is less quantity demanded (consumed) than quantity supplied (produced). This is called a surplus.

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Utility Maximization

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when making a purchase decision, a consumer attempts to get the greatest value possible from expenditure of least amount of money. His or her objective is to maximize the total value derived from the available money.

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Consumer Surplus

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Consumer surplus depends on the maximum price a consumer is willing to pay for a particular good. If the price of this particular good is less than the maximum price the consumer is willing to pay, the consumer gains consumer surplus.

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Producer Surplus

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producer surplus depends on the minimum price producers are willing to sell their goods. The producer gains producer surplus when consumers are willing to pay more than the producer’s minimum price.