Study Guide for Midterm 2 (Chapters 6-9, 19)

# Study Guide for Midterm 2 (Chapters 6-9, 19) - Chapter 6...

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Chapter 6: Price Elasticity of Demand (5 Questions) What is the meaning of the “Price Elasticity of Demand?” Definition o The responsiveness or sensitivity of consumers to a price change Background o Founded by Alfred Marshall o Elasticity means as the percentage change in the quantity taken divided by the percentage change in price when the price change is small Types of demand o Elastic demand (low profit margin) E d > 1 % change in quantity demanded is greater than %change in price Relatively horizontal slope of demand curve o Inelastic demand (high profit margin) E d < 1 % change in price is greater than % change in quantity demanded Very steep slope of demand curve o Unitary demand E d = 1 % change in price is equal to % change in quantity demanded Only applies to perishable goods

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Calculating the Price Elasticity of Demand o Midpoint Formula E d = change in quantity ÷ change in price sum of quantities/2 sum of prices/2 Graphs of Price Elasticity of Demand o pg. 109 Graphs of Relation between Price Elasticity of Demand and Total Revenue o pg. 111 Impact on Total Revenue o Elastic Demand Price Increases Total Revenue Decreases Price Decreases Total Revenue Increases o Inelastic Demand Price Increases Total Revenue Increases Price Decreases Total Revenue Decreases Determinants of Price Elasticity of Demand o Substitutability The larger the number of substitute goods that are available the greater the price elasticity of demand o Proportion of Income The higher the price of a good relative to consumers’ incomes, the greater the price elasticity of demand o Luxuries vs. Necessities
The more that a good is considered to be a luxury rather than a necessity, the greater the price elasticity of demand Electricity is regarded as a necessity because it difficult to get along without it. A price increase will not significantly reduce the amount of lighting and power used in a household. Vacation travel and jewelry are luxuries, which can easily be forgone. If the prices of vacation travel and jewelry rise, a consumer need not buy them and will suffer no great hardship without them. Common product like salt: Few good substitutes are available; salt is a negligible item in the family budget; it is a necessity rather than a luxury. That’s why it is highly inelastic. o Time Product demand is more elastic the longer the time period under consideration Consumers may not immediately reduce their purchases very much when the price of beef rises by 10%, but in time they may shift to chicken, pork, or fish. Another consideration is product durability Short-run demand for gas is more inelastic (0.2) than is long-run demand (0.7).

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