ECON 100 - Chapter 5 - Government Actions & Elasticity

  1. In what 3 ways does government interference in the market prevent equilibrium?
    1. Price Controls: (price floors and price ceilings).

    2. Quotas

    3. Taxes
  2. 1a. Give an example of why the government would impose a price ceiling
    1b. What is the primary effect?
    1c. Who is it designed to help?

    2a. Give an example of why the government would impose a price floor?
    2b. What is the primary effect?
    2c. Who is it designed to help?
    1a. price ceiling: Government may set rent controls to help people afford housing. Though it often makes things worse, because fewer rental units will be available available.

    Also, Venezuela and Zimbabwe both suffer from severe food shortages because government price ceilings designed to make food "more affordable."

    1b. There will be a shortage because producers will not earn enough revenue to cover their costs, and will produce less.

    1c. It is designed to help consumers

    2a. price floor: Minimum wage laws create a price floor designed to help the sellers of labour make more money.

    2b. This will create a surplus of labour, as the demand for jobs will decrease with the increase in price/wage.

    2c. It is designed to help producers
  3. When government imposes a tax on the market, what is included in the total surplus (TS)?
    TS = CS + PS + Tax Revenue (TR)
  4. 1. What is a quota?

    2. Give an example?

    3. What is the major difference between a quota and a tax?
    1. A quota is quantity control largely designed to help sellers earn more money.

    2. Canada imposes quotas for the amount of maple syrup produced to help keep the price high for producers. Similar quotas are in place to keep the price of dairy products artificially high. 

    Quotas are important to protect fragile and depleting industries such as fisheries and game.

    3. The difference between a quota and a tax, is that the seller gets to keep the extra revenue known as the quota rent instead of the government.
  5. 1. What is elasticity?

    2. What important economic question does the study of elasticity help answer?
    1. The degree to which consumers and producers change the quantity demanded or supplied as the price changes. 

    Or how responsive producers and consumers are to changes in price.

    * In other words, it measures how sensitive they are to price changes.

    2. How businesses can make more money. Revenue = expenditures = P x Q
  6. What is the formula for revenue?
    Revenue = expenditures = P x Q
  7. 1. What is elastic demand?

    2. Give 2 examples of goods with elastic demand.

    3. What is inelastic demans?

    4. Give 2 examples of goods with inelastic demand.
    1. Elastic demand is when Qd changes a lot in response to a change in price. 

    2. Anything that consumers don't really need is elastic. 

    • a. Luxury goods
    • b. Goods with a lot of close substitutes - such as Esso gas specifically

    3. Inelastic demand is when Qd changes very little in response to a price change. 

    4a. Necessities such as medicine, gas in general, basic foods and TP.

    b. Goods without close substitutes such as avacados.
  8. What is the formula for Price Elasticity of Demand?
    The % change in Qd relative to the % change in price.

    Price Elasticity of Demand = [%ΔQd / %ΔP]

    *The [ ] symbols mean absolute value - no negative numbers.

    The full formula measuring the change in Qd and P is: (Q2 - Q1 / Q2 + Q1) ÷ (P2 - P1 / P2 + P1)
  9. Steak dinners at the Keg:

    The price falls from $40 to $30 and the quantity demanded for steak dinners increases from 50 to 200. 

    Calculate the Price elasticity of demand
    Formula:

    (Q2 - Q1 / Q2 + Q1) ÷ (P2 - P1 / P2 + P1)

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    (200 - 50 / 200 + 50) ÷ (30 - 40 / 30 + 40)

    0.6 ÷ -0.14

    -4.28 

    * but since it is measure in absolute value, it is simply 4.28
  10. Suppose the price of diamond earrings decreases by 40% and Elaineès price elasticity of demand for diamond earrings is 3.8. By how much % will Elaine's quantity demanded change?
    Since the % change is already given (40%) as well as the price elasticity of demand, we only need to use the simple formula.

    %ΔQd / %ΔP

    3.8 = [x% / -40%]

    x% = 3.8 x 40 *no negative number*

    x% = 152%
  11. 1. If elasticity is more than one, the demand for the good is...

    2. If elasticity is less than one, the demand for the good is...

    3. If elasticity equals 1, the demand for the  good is...
    1. Elasticity > 1 : Elastic

    2. Elasticity < 1 : Inelastic

    3. Elasticity = 1 : Unit elastic

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  12. When we write elasticity, do we or do we not write it as a percentage? Why or why not?
    When we indicate elasticity, no % symbol is needed because they cancel each other out in the General Formula

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  13. Explain the relationship between elasticity and Total Revenue (TR) or Total Expenditure (TE)
    TR = TE = P x Q

    The effect of the increasing price outweights the effect of the decreasing quantity on the right side of the demand curve from P10 Q0 until P5 Q5

    The effect of the decreasing quantity from P5 Q5 to P10 Q0 outweighs the effect of the increasing price. 

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  14. What are the two effects of price changes on Total Revenue (TR)?

    Where would you label these effects on a demand curve?
    1. Price effect = ΔTR because of a different price per unit sold

    2. Quantity effect = ΔTR because of the change in Qd at the new price

    Label these effects as below:

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  15. Calculate the price effect and quantity effect for the three price changes

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    For the price effect, multiply the change in price by the original quantity

    For the quantity effect, multiply the new price by the change in quantity

    Or find the area in the price effect rectangle and the quantity effect rectangle

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  16. 1. What is the effect of inelastic demand on TR? (3)

    2. What is the effect of elastic demand on TR? (3)

    3. What is the effect of unit elastic demand on TR? (3)
    • 1. Inelastic demand means that elasticity <1
    •     %Δ Qd / %ΔP < 1 
    •     a. The price effect is stronger
    •     b. An increase in price will increase TR
    •     c. A decrease in price will decrease TR

    • 2. Elastic demand means that elasticity >1
    •     %Δ Qd / %ΔP > 1 
    •     a. The quantity effect is stronger
    •     b. An increase in price will decrease TR
    •     c. A decrease in price will decrease TR

    • 3. For a unit elastic good, %Δ Qd / %ΔP = 1 
    • So a change in price will not affect TR
  17. 1. What is the relationship between demand slope and elasticity?

    2. What does it mean when a good is perfectly inelastic?
    What is the formula?
    Give an example.

    3. What does it mean when a good is perfectly elastic
    What is the formula?
    Give an example.
    1. Generally, steeper demand curves are more inelastic, and flatter demand curves are more elastic.

    • 2. When a good is perfectly inelastic, Qd does not change at all in response to a price change. %ΔQ = 0
    • Example: Insulin

    • 3. When demand for a good is perfectly elastic, Qd decreases to 0 with any increase in price.  %ΔQ = ∞
    • Example: Goods with perfect substitutes such as Esso gas.
    • *Even if the price changes by one cent, people will go to the competition.
  18. What are the three determinants of elasticity?
    1. Availability of substitutes: Elasticity is higher if more substitutes are available, and vice-versa

    • eg. For eggs elasticity = 0.1
    • eg. Chevrolet automobiles = 4.0

    2. Necessity: Elasticity is lower if good is considered a necessity, and vice versa

    • eg. foreign travel = 4.1
    • eg. restaurant meals = 2.3
    • eg. coffee = 0.25

    3. Time: Over time, people find more substitutes, so elasticity is often larger when measured over the long run than in the short run.

    • eg. gasoline short run elasticity = 0.2
    • eg. gasoline long run elasticity = 0.7
    • *Because if the price of gas is too high in the long run, people will find more fuel efficient vehicles.
  19. 1, What is the cross-price elasticity of demand? (2)

    2. What is the formula for cross price elasticity of demand?

    3. What is the major difference to remember between the formula for cross price elasticity of demand, and the original price elasticity of demand formula?
    1a. How much a demand curve shifts when there is a change in the price of substitutes or compliments.

    b. The cross price elasticity of demand describes how much Qd changes for good A when the price of related good B changes.

    • 2. See below:
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    3. There are no absolute value [ ] symbols because we want to know if the relationship is positive or negative.
  20. 1. What is the cross price elasticity of demand for compliments?

    2. What is the cross price elasticity of demand for substitutes?
    1. For complements there is a negative relationship between PB and Qd, so the cross price elasticity < 0.

    2. For substitutes, there is a positive relationship between pB and Qd, so cross price elasticity > 0.
  21. What does it mean if cross price elasticity is a small number (positive or negative)?

    Give and example.
    The relationship between the goods is weak Therefore, the larger elasticity between the two goods, the stronger the relationship.

    • Eg. Butter and margarine: E = 0.81
    • Eg. Beef and pork: E = 0.28

    So people are more likely to substitute butter for margarine than they are for beef and pork.
  22. 1, What is income elasticity of demand?

    2. What is the formula?
    1. How much does the demand curve shift when income changes.

    2. See below.

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  23. 1. What is the income elasticity of demand for normal goods?

    2. What is the income elasticity of demand for inferior goods?

    3. What is the income elasticity of luxury goods

    4. What is the income elasticity for necessities?
    1. For normal goods, income elasticity is > 0. (positive number) *A normal can be broken down further, into necessities and luxury goods).

    2. For inferior goods, income elasticity is < 0. (negative number)

    3. If the good is > 1, it is a luxury good. (income elastic)

    4. If the good is > 0 but < 1, it is a necessity. (income inelastic)
  24. What type of goods are the following in terms of income elasticity?

    1. Food eaten at home - E = 0.5
    2. Restaurant meals - E = 1.4
    3. Cigarettes - E = 0.6
    4. Public transportation - E = -0.4
    • 1. Food eaten at home: E = 0.5 normal necessity
    • 2. Restaurant meals:  E = 1.4 normal luxury 
    • 3. Cigarettes: E = 0.6 normal necessity
    • 4. Public transportation: E = -0.4 inferior good
  25. 1. What is price elasticity of supply?

    2. What is the formula?

    3. What is the difference between the formula for demand elasticity and supply elasticity?
    1. How much Qs changes when the price changes

    • 2. See below
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    3. It is exactly the same formula but doesn't need the absolute value signs.
  26. 1. If elasticity < 1, then supply is ....

    2. If elasticity > 1, then supply is ...

    3. If elasticity = 1, then supply is ...
    1. If elasticity < 1, then supply is inelastic

    2. If elasticity > 1, then supply is elastic

    3. If elasticity = 1, then supply is unit elastic
  27. What is the price elasticity of supply when the price changes from $3 to $4?

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  28. Explain the three factors that affect elasticity of supply? Give examples.
    1. Availability of inputs: When it is difficult to obtain inputs, supply will be inelastic.

    When it is easy to obtain inputs, supply will be elastic. 

    2. Productive capacity: If a busineses has idle capacity they can respond more quickly to a price increase. This will lead to elastic supply. ex. A farm has many tractors in the barn not being used, so they can easily increase production if they need to. 

    If production is close to full capacity however, supply will be inelastic. 

    3. Time: More time to respond will equal more elastic supply.

    eg. Oil: Oil production requires time to explore and set up for extraction, so the Qs can only change significanltly in the long run.
  29. 1. What is perfectly elastic supply?

    What does the curve look like?
    Give an example

    2. What is perfectly inelastic supply?

    What does the curve look like?
    Give an example.
    1. Perfectly elastic supply: If the price is any lower than what it takes to cover the cost, than they won't produce it at all. 

    It is a flat curve.

    ex. Online music.

    2. Perfectly inelastic supply: If there is a fixed quantity of something, then the price will just keep going exponentially.

    The curve is completely vertical.

    Ex. Land on an island
Author
MissionMindhack
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Card Set
ECON 100 - Chapter 5 - Government Actions & Elasticity
Description
Preparation for Midterm #2
Updated