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SECTION 3
Application of the Demand and Supply Model - Part 1
42
Economics
Undergraduate 1
08/03/2017

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Term
How an INCREASE IN DEMAND Affects the Equilibrium
Definition
Hot weather increases:
[image]
Term
How a DECREASE IN DEMAND Affects the Equilibrium
Definition
Earthquake reduces demand on ice cream
[image]
Term
What does 'Ambiguous' mean?
Definition
Equilibrium could go up or down if both the Supply and Demand curve shift
Term
What does the change in an ambiguous change depend on?
Definition
Depends on the RELEVANT SIZE of the shift, so will not know until you know the size of the shift of both curves.
Term
when can an Ambiguous shift occur?
Definition
When both the Supply and Demand curves shift
Term
Reasons why curves may shift - BUYER'S SIDE
Definition
- Tastes
- Income
- Price of other goods
- Number of buyers
Term
Reasons why curves may shift - SELLER'S SIDE
Definition
- Price of inputs
- Environment
- Number of suppliers
- Technology
Term
Reasons why curves may shift - GOVERNMENT INTERFERENCE
Definition
- Tax on goods
- Price floor
- Price ceiling
Term
What does ELASTICITY mean?
Definition
The measure of the sensitivity or responsiveness (extreme sensitivity or not?)
Term
What does PRICE OF DEMAND (PED) mean?
Definition
Measures how sensitive quantity is to the price
Term
PED Formula
Definition
PED = (Price 1/ Quantity 1) x (1/Slope)
Term
PED note on negative sign...
Definition
The larger the elasticity number, the more sensitive it is IGNORING THE SIGN (focus on the ABSOLUTE VALUE)
E.G. PED=-2 compared to PED=-4, - 4 is more elastic
Term
Elasticity of the demand curve at Midpoint example
Definition
[image]
Term
Elasticity of the demand curve at Midpoint characteristics
Definition
- The price elasticity of demand at MIDPOINT of demand curve is ALWAYS 1.
- Midpoint is when total revenue is MAXIMISED
Term
Elasticity of demand curve point A - Low Demand and high price example
Definition
[image]
Term
Elasticity of the demand curve when PED is GREATER than 1?
Definition
Demand is ELASTIC
Term
Elasticity of demand curve point B - High Demand and Low price example
Definition
[image]
Term
Elasticity of the demand curve when PED is LOWER than 1?
Definition
Demand is INELASTIC
Term
Why is elasticity not the same as slope?
Definition
Elasticity changes over the linear demand curve.
Above 1 is elastic
Midpoint (max revenue) = 1
Below 1 is inelastic
Term
What is this graph called, and what does it indicate?
[image]
Definition
ELASTIC
=> Perfect competition
- Value for horizontal is infinite
- If you raise the price by one cent, quantity is so sensitive you will make no sales
Term
What is this graph called, and what does it indicate?
[image]
Definition
INELASTIC
=> Perfectly inelastic/vertical
- Value here for PED=0, can charge any price you want and quantity will not falter
Term
What is Total Revenue?
Definition
Is the amount paid by buyers and received by sellers of a good
Term
Total Revenue equation
Definition
TR = P x Q
Term
When is total revenue is at total maximum
Definition
When PED=1
Very hard to find that point in real life
Term
With an inelastic Demand Curve (PED<1), what happens when price increases?
Definition
Leads to a decrease in quantity that is proportionately smaller, so total revenue will INCREASE.
Term
With an inelastic Demand Curve (PED<1), what happens when price decreases?
Definition
Leads to an increase in quantity that is proportionally smaller, thus total revenue DECREASES.
Term
With an elastic Demand Curve (PED>1), what happens when price increases?
Definition
Leads to a decrease in quantity demanded that is proportionally larger, so total revenue DECREASES.
Term
With an elastic Demand Curve (PED>1), what happens when price decreases?
Definition
Leads to a decrease in quantity demanded that is proportionally larger, so total revenue INCREASES.
Term
Why will the value of elasticity always be negative when wither price or quantity changes?
Definition
Because if price increases, quantity will decrease (negative)
and if quantity increases, this indicates price decreased (negative). Therefore on of the two will awakes be a negative value input into the PED = P/Q x 1/slope equation.
Term
Does it matter if the elasticity is negative?
Definition
No because we always take the ABSOLUTE value, which means that in most cases what we care about is the magnitude of that number and ignore the negative sign.
e.g. a 10% increase (decrease) in price will lead to a 20% decrease (increase) in quantity demanded.
Term
What is Cross Elasticity of Demand?
Definition
The responsiveness of quantity demanded to a given change in the price of another good.
Term
What does Cross Elasticity of Demand depend on?
Definition
On whether the good is a complement or a substitute.
Term
Cross Elasticity Substitute tea example
Definition
Price of Tea INCREASES
Quantity of tea demanded DECREASES

Quantiy of coffee demanded INCREASES
Term
Will the Cross Elasticity of Substitutes be negative or positive and why?
Definition
POSITIVE

Because if price of tea increases, demand of coffee increases = +,+ = positive

Price of tea decreases, demand of coffee decreases = -,- = positive
Term
Will the Cross Elasticity of Complements be negative or positive and why?
Definition
NEGATIVE

If price of coffee increases, demand of coffee creamers goes down = +,- = negative

If price of coffee decreases, demand of coffee creamers increases = -,+ = negative
Term
Ranges of Elasticity - Perfectly Elastic (Horizontal Line) [image]
Definition
ES = ∞
Term
Ranges of Elasticity - Relatively Elastic
[image]
Definition
ES > 1
Term
Ranges of Elasticity - Unit Elastic
[image]
Definition
ES = 1
Term
Ranges of Elasticity - Relatively Inelastic
[image]
Definition
ES < 1
Term
Ranges of Elasticity - Perfectly Inelastic
[image]
Definition
ES = 0
Term
What does an Inelastic mean?
Definition
insensitive to changes in price or income.
Term
What does an elastic mean?
Definition
sensitive to changes in price or income.
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