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50 Cards in this Set
- Front
- Back
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Price ceiling
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Maximum legal price at which a good or service can be sold. Intent is to help the buyer.
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Price floor
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Minimum legal price at which a good or service can be sold. The intent of this is to protect the seller. Example minimum wage you cannot purchase labor without repaying a certain amount.
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What happens when you set a price floor?
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Installed when prodcuers feel the market equilibrium price is too low.
Creates a surplus at a price above equilibrium. If the government purchases the surplus, taxpayers end up footing the bill. Consumers pay more for less output. There is overinvestment because you can get more than the market price. Inefficient producers can survive. |
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What happens when you set a price ceiling?
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A price ceiling is installed when consumers feel the market equilibrium is too high.
A price ceiling creates a permanent shortage at a price below equilibrium. Black markets and crime develop. deterioration of quality. charge fees for other stuff like parking to get their money. Under investment in the industry. |
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There are no price floors or ceilings that have a good effect.
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They all produce negative consequences. Nevertheless, they prevail.
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Elasticy explains:
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Alot of stuff like why a hardback book price is so different from a softback book price. If you know the elasticity of the product you're selling you can set prices.
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Elasticity
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Measure of responsiveness. Measures the sensitivity or responsiveness of a choice to a change in an external factor, such as price.
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Equation for elasticity
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%change in quantity demanded / %change in price.
Always negative, however we report it as positive. It is negative because the law of demand is always NEGATIVE. |
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If elasticity is less than 1 then
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the product is inelastic. Not flexible. Consumers are not very responsive to a change in price. Consumers are price blind. Such as gasoline or medecine.
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If elasticity is greater than 1
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ELASTIC. If price goes up we won't buy it. Price sensitive. Luxury items.
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If the elasticity is 1
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unit elastic. The percentage change in Quantity demanded equals the % change in price, but they move opposite directions.
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Inelastic curve shape will be
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Steep
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Elastic curve
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More horizontal.
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Perfectly inelastic
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There will be a straight vertical line.
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Perfectly elastic,
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There is a straight horizontal line. Consumers will buy any quantity but only at one price. A change in the price will cause an infinite drop and they will demand zero.
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Elasticity is based on
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Relative changes so it is different at all points on the demand curve.
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What effect does prices have on elasticity?
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At high prices goods are more elastic. At lower prices we are inelastic. If we are paying more for it we are more sensitive to price.
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Mid point formula
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(Q2-Q1 / Q2+Q1) x (P2+P1 / P2-P1)
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Determinants of the price elasticity of demand
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1. Degree of necessity.
2. Availability of substitutes. 3. Share of budget spent on good or service. 4. Time period. |
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Degree of necessity
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Determinant of demand elasticity. Don't think of it as food and clothing and necessities. Think individual people think they can't live without it. Like cigarettes.
The more necessary the good or service the more inelastic its demand. Like gas, cigarettes, food, clothing, shelter, cell phones. --Luxury goods or services have a more elastic demand. If you're going to buy a yacht or eat out, if the price goes up you'll refrain. |
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Availability of substitutes
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Determinant of elasticity of demand.
If few substitutes exist the price is more inelastic because they have to buy it and it's only available at the one price. If lots of substitutes exist then the elasticity of demand is more elastic. If the price of a big mac changes you can buy a whopper instead. the more narrowly you define your market, the more elastic your results are because there are more substitutes. |
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Share of budget spent on a good or service
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Determinant of the elasticity of demand.
--If the good takes a large % of your income then it is elastic. You respond if the price changes. --If it takes a small % of your income then you don't care as much so it is now more elastic. Example~Textbooks Vs. Pencils: If you raise the price of books by 10% students will take fewer classes or not buy the books. However, if you raise the price of pencils 10% they will still buy it because it is a small price relative to their income. |
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Time period
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Determinant of the elasticity of demand.
-Short period the elasticity is more inelastic because you don't have time to adjust. -however, over a long period of time, it becomes elastic because you have time to adjust. Example: Gas goes to $7 overnight. Have to buy gas to get to work. However, after a few days you can buy a hybrid car or ride a bike and adjust your behavior. |
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Profit equation
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Profit=total revenue - total cost.
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Total revenue equation
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Total revenue = price x quantity sold.
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If inelastic and P up and Q down what happens to Revenue
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TR goes up
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If inelastic and P down, Q up what happens to revenue?
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TR goes down.
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If elastic and P goes up and Q goes down What happens to total revenue?
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TR goes down
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If elastic and P goes down and Q goes up, what happens to total revenue?
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TR goes up
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If it is unit elastic it what happens to total revenue?
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TR stays the same.
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Excise taxes
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Per unit taxes paid to the govt. by the seller. If you run QT there is a $2 excise tax on ciggarettes you have to give $2 to govt.
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Reasons why we have excise taxes:
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1. We want to raise tax revenue.
2. Taxes discourage consumption (sin taxes) |
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Why don't luxury tax policies work?
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Luxury tax policies put into effect to try and raise revenue fail because the demand is very elastic. People will no longer buy the luxury items.
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Who pays the excise tax when the good is inelastic? When the good is elastic?
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When the good is inelastic, the consumer ends up paying the tax through a higher price. When the good is elastic, producers end up paying most of it because they cannot raise the price.
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Income elasticity of demand equation
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Income elasticity of demand = % change in quantity demanded / % change in income.
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If the elasticity of income is greater than 0 what kind of good is it?
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It is a normal good
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If the elasticity of income is less than 0 what kind of good is it?
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Inferior goods
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If the elasticity of income is
0 < Ei < 1 |
then it is a necessity
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If the elasticity of income is
Ei > 1 |
The item is a luxury
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Cross price elasticity equation
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Cross price elasticity = % change in quantity demanded of good 1 / % change in price of good
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Elasticity of supply equation
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Elasticity of supply = % change in Q supplied / % change in price.
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What does the supply elasticity depend on and why?
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Whether or not we supply more depends on the time period under consideration. In the beginning we can't produce much more but then as time goes on we can adjust and produce more.
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What are the three time periods?
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1. Market period
2. Short run 3. Long run |
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Market period
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During this time supply is perfectly inelastic. The quantity of output cannot change because we don't have the necessary resources.
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Short run
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Time period in which @ least 1 input in production is fixed in amount. We can produce some more but not a lot.
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Long run
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A time period long enough to vary all the inputs. Es will still be relatively elastic.
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Shape of elastic curve
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flat
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shape of inelastic curve
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steep
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What happens when 2 goods have a positive relationship?
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They are substitutes.
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What happens when 2 goods have a negative relationship?
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They are complements.
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