Week 3

• elasticity

  measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants
• price elasticity of demand

  how much quantity demanded responds to a change in price; price-sensitivity of buyers' demand

  $\text{price elasticity of demand} =$$\frac{\text{percentage change in QD}}{\text{percentage change in P}}$
• percentage change formula


  $\text{percentage change} =$$\frac{\text{end value} - \text{start value}}{\text{midpoint}}\cdot 100$
• perfectly inelastic demand

  consumers are not at all sensitive to changes in price; 0

  
• inelastic demand

  consumers are relatively sensitive to changes in price; <1

  
• unit elastic demand

  1

  
• elastic demand

  consumers are sensitive to changes in price; >1

  
• perfectly elastic demand

  consumers are extremely sensitive to changes in price; $\infin$

  
• determinants of price elasticity of demand

  • how broadly/narrowly the good is defined
  • whether the good is a necessity/luxury
  • the extent to which close substitutes are available
  • how expensive the good is
  • time horizon: elasticity is higher in the long run than in the short run
• cross-price elasticity of demand

  how much quantity demanded responds to a change in price of another good

  $\text{cross-price elasticity of demand} =$$\frac{\text{percentage change in quantity demanded of good 1}}{\text{percentage change in price of good 2}}$
• substitutes

  cross-price elasticity of demand > 0
• complements

  cross-price elasticity of demand < 0
• income elasticity of demand

  how much quantity demanded responds to a change in income

  $\text{income elasticity of demand} =$$\frac{\text{percentage change in QD}}{\text{percentage change in income}}$
• normal goods

  income elasticity > 0
• inferior goods

  income elasticity < 0
• price elasticity of supply

  how much quantity supplied responds to a change in price

  $\text{price elasticity of supply} =$$\frac{\text{percentage change in QS}}{\text{percentage change in P}}$
• perfectly inelastic supply

  suppliers not at all sensitive to changes in price; 0

  
• inelastic supply

  suppliers slightly sensitive to changes in price; <1

  
• unit elastic supply

  1

  
• elastic supply

  suppliers sensitive to changes in price; >1

  
• perfectly elastic supply

  suppliers extremely sensitive to changes in price; $\infin$

  
• determinants of price elasticity of supply

  • how easily sellers can change the quantity they produce
  • time span
• the more easily sellers can change the quantity they produce

  the greater the price elasticity of supply
• for many goods, the price elasticity of supply is greater in the long run than


  in the short run
• elasticity

  a measure of the responsiveness of QD or QS to one of its determinants (price, price of a related good, income)
• willingness to pay (WTP)

  the maximum amount a buyer will pay for a good; measures how much the buyer values the good
• a buyer will only buy a good if

  his willingness to pay (WTP) is at least as high as the price
• cost for consumers

  the price of a good
• cost for producers

  the value of everything a seller must give up to produce a good

  • cost of inputs + value of the sellers' time
  • measure of willingness to sell
• marginal seller

  seller who would leave the market if the price were any lower
• marginal buyer

  buyer who would leave the market if the price were any higher
• the flatter the curve

  the greater the elasticity
• the steeper the curve

  the smaller the elasticity
• $\text{revenue} =$$\text{P} \cdot \text{Q}$
• as price increases

  revenue increases
• as quantity decreases

  revenue decreases
• demand is elastic

  revenue decreases
• demand is inelastic


  revenue increases
• welfare economics

  studies how the allocation of resources affects economic well-being
• allocation of resources

  how much of each good and service is provided

  which producers produce them

  which consumers consume them