ECON 2000 Chapter Notes - Chapter 5: Demand Curve

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24 Jun 2014

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Chapter 5 summary: elasticity is a general measure of responsiveness that can be used to quantify many different relationships. For this reason, elasticities are calculated using percentages. 1: perfectly elastic demand describes a relationship in which a small increase in the price of a product causes the qd for that product to drop to 0. Calcualted elasticities p. 100: there are a number of ways to calculate elasticity. If demand is inelastic, a p will tr(total revenue): if demand is elastic, a price cut will cause qd by a greater % than the % p and tr will . If demand is inelastic, a price cut will cause qd by a smaller % than the % p and tr will . The determinants of demand elasticity p. 107: the elasticity of demand depends on (1) the availability of substitutes, (2) the importance of the item in individual budgets, & (3) the time frame in question.

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Discussion #1

The law of demand states that a fall in the price of a good raises the quantity demanded, and the increase in price leads to a decrease in quantity demanded. The price elasticity of demand measures the responsiveness of the quantity demanded to a change in price. Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price, and the percentage change in quantity demanded is greater than the percentage change in price. Demand is said to be inelastic if the quantity demanded responds only slightly to changes in the price, which indicates that the percentage in price is greater than the percentage in quantity demanded.

However, the extent of responsiveness of quantity demanded to a change in price depends on the nature of a particular good or service in the market. The price elasticity of demand partly depends on the availability of close substitutes. When a large number of substitutes are available, consumers respond to a higher price of a good by buying more of the substitute goods and less of the relatively more expensive good. In addition, goods or services that are considered necessities tend to have less elastic (more inelastic) demand, whereas goods or services that are considered luxuries have more elastic (less inelastic) demands.

Explain why the demand for the good or service provided by the organization you work for is elastic or inelastic. How does this influence pricing decisions?
Provide examples on how the availability of close substitutes affects price elasticity of demand.
Give specific examples of necessities or luxuries, and explain how they affect price elasticity of goods or services.

Please answer ALL bulletins and place the answers under the correct bulletin.

interval (or arc) elasticity

cross-price elasticity

price elasticity of demand

elastic demand

income elasticity

inelastic demand

inframarginal units

marginal revenue

point elasticity

price effect

quantity effect

total revenue

unitary elastic demand

1. __________________ A measure of consumersâ sensitivity or responsiveness to changes in the price of a good or service.

2. ___________________ When the percentage change in price (in absolute value) is more than the percentage change in quantity demanded (in absolute value).

3. ___________________ When the percentage change in quantity demanded (in absolute value) is more than the percentage change in price (in absolute value).

4. ___________________ When the percentage change in quantity demanded (in absolute value) is just equal to the percentage change in price (in absolute value).

5. ___________________ Total amount paid to a producer for a good or service P * Q.

6. ___________________ The effect on total revenue of a change in price, holding quantity constant.

7. ___________________ The effect on total revenue of a change in quantity, holding price constant.

8. ___________________ An elasticity calculated over an interval of a demand curve or demand schedule.

9. ___________________ Elasticity at a specific price or point on a demand curve.

10. ___________________ A measure of how responsive quantity demanded is to a change in income, all other things constant.

11. ___________________ A measure showing how responsive the quantity demanded of one good is to changes in the price of another good, other factors constant.

12. ___________________ The additional revenue received by producing and selling one more unit of output.

13. ___________________ Units of output that could have been sold at a higher price had the firm not lowered its price to sell additional (marginal) units.

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1. Using supply-and-demand diagrams, show the effect of the following events on the market for sweatshirts.

(a) A hurricane in South Carolina damages the cotton crop.

(b) The price of leather jackets falls.

(d) New knitting machines are invented.

2. (a) What is the definition of quantity demanded?

(b) What is the definition of quantity supplied?

(d) Choose one of the factors from part (b) and consider the market for bananas. On a well-labeled diagram, demonstrate what will occur in this market if there is a change in this factor.

(e) List the 4 factors that cause the supply curve to shift to the left or the right.

(f) Choose one of the factors from part (e) and consider the market for scooters. On a well-labeled diagram, demonstrate what will occur in this market if there is a change in this factor.

(g) Choose one factor from part (b) and another from part (e) and consider the market for minivans. On a well-labeled diagram, demonstrate what will occur in this market given the change in both factors. (Hint: Draw separate diagrams for parts (d), (f), & (g))

3. Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are as follows:

page1image3877024

(a) Draw the demand and the supply curves. What is unusual about this supply curve? Why might this be true?

(b) What are the equilibrium price and quantity of tickets?

(c) Your college plans to increase total enrollment next year by 5,000 students. The additional students will have the following demand schedule:

page1image3870304

Now add the old demand schedule and the demand schedule for the new students to calculate the new demand schedule for the entire college. What will be the new equilibrium price and quantity?

4. Market research has revealed the following information about the market for chocolate bars: The demand schedule can be represented by the equation QD = 1600 − 300P, where QD is the quantity demanded and P is the price. The supply schedule can be represented by the equation QS = 1400 + 700P, where QS is the quantity supplied.

(a) Sketch a graph representing the market for chocolate bars. Identify the equilibrium point on your graph.

(b) Calculate the equilibrium price and quantity in the market for chocolate bars.

5. For each of the following pairs of goods, which good would you expect to have more elastic demand and why?

(a) Required textbooks or mystery novels

(b) Beethoven recordings or classical music recordings in general

(d) Root beer or water

(e) Insulin or Tylenol

(f) Food or bananas

6.Consider the following information from the market for lemonade:

Price	Quantity Demanded	Quantity Supplied
$1	500 cups	150 cups
$2	200 cups	310 cups

(a) As the price changes from $1 to $2, what is the value of price elasticity of demand?

(b) As the price changes from $1 to $2, what is the value of price elasticity of supply?

(c) Sketch a diagram demonstrating the market for lemonade. Are the supply and demand curves relatively inelastic or elastic? Explain.

(d) Suppose that when the price of lemonade increases from $1 to $2, the quantity demanded of orange juice increases from 150 cups to 190 cups. Calculate cross-price elasticity of demand for orange juice.

(e) Are orange juice and lemonade substitute or complementary goods? Explain.

7. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston:

page2image1834528

(a) As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travelers and (ii) vacationers? (Use the midpoint method in your calculations)

(b) Why might vacationers have a different elasticity from business travelers?

8. Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the long run.

(a) If the price of heating oil rises from $1.80 to $2.20 per gallon, what happens to the quantity of heating oil demand in the short run? In the long run? (Use the midpoint method in your calculations)

(b) Why might this elasticity depend on the time horizon?

9. The Government has decided that the free-market price of cheese is too low.

(a) Suppose the government imposes a binding price floor in the cheese market. Draw a supply-and-demand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese?

(b) Farmers complain that the price foor has reduced their total revenue. Is this possible? Explain

(c) In response to farmer's complaints, the government agrees to purchase all the surplus cheese at the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses?

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ECON 2000 Chapter Notes - Chapter 5: Demand Curve

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