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Final Exam Review content from chapters 4,5,8,10,11,12,13 and 14. includes diagrams and a few review questions at the end

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ECON 101
Usman Hannan

Chapter 4: Elasticity Elasticity of Demand price elasticity of demand: measures the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same price elasticity of demand = % change in quantity demanded/% change in price E = change in Q/Q ave. x P ave./change in P perfectly inelastic demand: if the quantity demanded remains constant when the price changes then the price elasticity of demand is 0 unit elastic demand: percentage change in quantity demanded equals the percentage change in price, equals 1 inelastic demand: elasticity is between 0 and 1 ex. Necessities like food and shelter perfectly elastic demand: quantity demanded changes by an infinitely large percentage in response to a tiny price change ex. Soft drinks elastic demand: elasticity is >1, for luxury items ex. Cars, furniture ex. price changes from $25 to $15; quantity increases from 0 to 20 E = 20/10 x 20/10 = 4 total revenue: equal to P x Q 1. if a price cut increases revenue, demand is elastic 2. if a price cut decreases revenue, demand is inelastic 3. if a price cut leaves total revenue the same, demand is unit elastic total revenue test: estimating price elasticity of demand by observing the change in the total revenue that results from a change in price Factors Affecting Elasticity of Demand 1. closeness of substitutes the more substitutes, the more elastic the demand 2. proportion of income spent on the good the greater the proportion of income spent on the good, the more elastic the demand is 3. time elapsed since price change the longer the time has elapsed, the more elastic it is cross elasticity of demand: measure of the responsiveness of the demand for a good to change in the price of a substitute or compliment cross elasticity of demand = % change in quantity demanded/(% change in the price of a substitute+ or compliment-) ex. substitute the price of pizza is constant, quantity changes from 9 to 11 the price of a burger changes from $1.50 to $2.50 change in Q/Q ave. =2/10 = 20% increase in quantity demanded change in P/P ave. = $1/$2 = 50% increase in price CEOD = 20%/50% = 0.4 ex. compliment price of drink from $1.50 to $2.50, change in quantity of pizza from 11 to 9 2/10 = 20% decrease in quantity demanded $1/2$ = 50% increase in price COED = -20%/50% = -0.4 income elasticity of demand: measure of the responsiveness of the demand for a good or service to a change in income income elasticity of demand = % change in quantity demanded/ % change in income 1. when the demand for a good is income elastic, the % of income spent on that good increases as income increases 2. when the demand for a good is income inelastic, the % of income spent on that good decreases as income increases inferior goods: the quantity demanded of an inferior good and the amount spent on it decreases when income increases ex. McDonald's vs high class restaurant Elasticity of Supply elasticity of supply: measures the responsiveness of the quantity supplied to a change in the price of a good when all other influences on selling plans remain the same elasticity of supply = % change in quantity supplied/ % change in price Factors Affecting Elasticity of Supply 1. resource substitution possibilities goods that are produced by rarer resources tend to have an inelastic supply 2. time frame for the supply decision long run supply response of the quantity supplied to a price change after all technological methods have been exploited, supply is more elastic the longer time they have to adjust short run supply shows how the quantity supplied responds to a price change when only some technological adjustments have been made momentary supply shows the response of the quantity supplied immediately following a price change ex. Fruits may have perfectly inelastic supply curve because crops were planted earlier that year Chapter 5: Efficiency and Equity Resource Allocation 1. Market Price people who are willing to pay that price get the resource 2. Command allocates resources by the command of someone in authority 3. Majority Rule 4. Contest 5. First Come, First Served 6. Lottery 7. Personal Characteristics 8. Force Demand and Marginal Benefit 1. Demand Willingness to Pay and Value measure the marginal benefit by the max price that is willingly paid for another unit of a G or S; a demand curve is a marginal benefit curve 2. Individual Demand and Market Demand relationship between the price and quantity demanded and the relationship between the price of a good and the quantity demanded by all buyers is the market demand 3. Consumer Surplus value of a good minus the price paid for it Supply and Marginal Cost 1. Supply, cost and minimum supply price cost is what a producer gives up and receives price; a supply curve is a marginal cost curve 2. Individual Supply and Market Supply market supply curve is the marginal social cost curve 3. Producer Surplus price received for a good minus its minimum supply price summed over quantity sold Obstacles to Efficiency 1. Price and Quantity Regulations, ex. Rent, farm production 2. Taxes and Subsidies taxes decrease quantity produced; subsidies decrease P and increase $ received by seller, increase quantity (can lead to overproduction) 3. Externalities cost arises when an electric utility burns coal and a benefit arises when an apartment owner installs a fire detector and decreases neighbors risk 4. Public Goods and Common Resources public good is consumed by everyone simultaneously by everyone even if they don't pay for it ex. National Defence 5. Monopoly sole provider of a good or service It's Not Fair if the Result Isn't Fair 1. Utilitarianism principle that states we should strive to achieve the greatest happiness for the greatest number; income must be distributed equally; everyone has the same basic wants; the greater a person's income, the smaller the a marginal benefit of a dollar 2. The Big Tradeoff tradeoff between efficiency and fairness, the more income redistributed the greater the inefficiency 3. Make the Poorest as Well Off as Possible taxes must not be so high that they make the economic pie shrink too much It's Not Fair if the Rules Aren't Fair symmetry principle: people in similar situations must be treated similarly 1. the state must enforce laws that establish and protect private property 2. private property may be transferred from one person to another only by voluntary exchange Fairness & Efficiency if private property rights are enforced and if voluntary exchanges take place, resources will be allocated efficiently if there are no.. 1. price and quantity regulations
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