Microeconomics Final – Chapter 6

ratio of precent change in the quantity demanded to the percent change in the price as we move along the demand curve. It asks: if there is a 1% change in price, what is the percentage change in quantity demanded?

(Q2-Q1)/((Q1+Q2)/2)
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(P2-P1)/((P1+P2)/2)

When quantity demanded does not respond at all to changes in price; it is a vertical line and has an elasticity equal to 0
*An increase in price leaves the quantity demanded unchanged

When any price increase well cause quantity demanded to drop to 0; demand curve is horizontal and has a price elasticity equal to infinity
*At exactly $5 consumers will buy any quantity, so at any price above $5 the quantity demanded will drop to 0 and at any price below $5 the quantity demanded is extremely large

When an increase in price of a good leads to a 1 to 1 ratio in the decrease of the amount that is demanded; the price elasticity is equal to 1

price elasticity > 1

price elasticity is < 1

price elasticity is = 1

(% change in quantity demanded) / (% change in price)

These classifications of elasticity of demand predict how changes in the price of a good will affect the total revenue earned by producers of that good

Total Revenue equals total value of sales of a good or service
TR=PxQ

A price increase will cause each unit will sell for more

A price increase will cause fewer units will be sold

*If the price effect is stronger, raising a price will also increase revenue
*If the quantity effect is stronger, raising a price will decrease revenue

If demand is inelastic --> price increase will raise revenues; If demand is elastic --> price increase will lower revenues; if demand is unit elastic --> a price increase will not affect revenues

When the elasticity is high, a firm should lower prices
When the elasticity is low, a firm should raise prices

1) Whether a good is a necessity or a luxury
2) The availability of close substitutes
3) The share of income spent on the good
4) Time elapsed since the price change

1) High
2) Low

*If there are no close substitutes, the price elasticity is low
*If there are many close substitutes, the price elasticity is high

*If there is a high share of income spent on the good the demand for the good is relatively elastic
*If there is a low share of the good, the demand is relatively inelastic

*the price elasticity of demand tends to increase as consumers have more time to adjust

A measure of the responsiveness of the quantity of a good supplied to the price of that good. The price elasticity of supply tells you the percentage change in quantity supplied for a 1% change in price; It is equal to the (% change in quantity supplied)/(% change in price)

The price has no effect on quantity supplied; It is a vertical supply curve and has an elasticity equal to 0

Any fall in price causes quantity supplied to fall to 0 and any rise in price elicits an infinite quantity supplied; It is a horizontal supply curve and has an elasticity equal to infinity

The supply elasticity is < 1

The supply elasticity is > 1

1) Availability of inputs --> elasticity is high when inputs are easy to obtain; elasticity is low when inputs are difficult to obtain
2) Time elapsed since price change --> long-run price elasticity is often higher than the short-run

*If supply or demand are perfectly inelastic there is no DWL, the tax simply shifts surplus straight from consumers and producers to the government.
*The larger the number of mutually beneficial transactions lost, the larger the DWL

There is a larger DWL because there is a relatively large decrease in quantity transacted

There is a smaller DWL because there is a relatively small decrease in quantity transacted

It depends on the price elasticity of supply and demand

When the elasticity of demand is relatively inelastic (Meaning quantity demanded changes very little in response to a change in price) & the elasticity of supply is relatively elastic (meaning quantity supplied changes a lot in response to a change in price)
In other words: When the price elasticity of demand is low and the price elasticity of supply is high the burden of an excise tax falls mainly on the consumers.

When the elasticity of demand is relatively elastic and the the elasticity of demand is relatively inelastic
In other words, when the price elasticity of demand is high, substitutes are readily available as consumers can easily switch to cheaper options and when the price elasticity of supply is low, the suppliers have fewer substitutes to choose from. Therefore, the excise tax falls mainly on producers

When price elasticity of demand is higher than the price elasticity of supply, an excise tax falls mainly on the producer; when the price elasticity of supply is higher than the price elasticity of demand, an excise tax falls mainly on consumers.