CLEP Microeconomic Notes 1

# 38 market equilibrium where quantity supplied equals

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38) Market Equilibrium – where quantity supplied equals quantity demanded a) Equilibrium cannot occur when there is a price ceiling or floor. 39) Marginal Opportunity Cost – the amount of another product you give up producing to one more unit of product a) Ex: if producing another pair of jeans means you produce 3 less shirts, the marginal opportunity cost of the jeans is 3 shirts 40) Scarcest Resources – diamonds, platinum, gold a) Most expensive due to limited supply b) Used conservatively Elasticity 41) Price Elasticity of Demand –(PED) a mathematical formula to determine how much a change in price affects the quantity demanded a) The equation is % change in quantity demanded divided by % change in price a.i) Ex: if a 20% off sale increased quantity demanded by 60%, = price elastic (a.i.1) 60/20=3 (a.i.1.a) If the Price Elasticity of Demand (PED) is equal to 1, demand is unit elastic (a.i.1.b) If the Price Elasticity of Demand (PED) is greater than 1, demand is elastic (sensitive to changes in price) b) Applies to both supply and demand b.i)Inelastic Demand – the quantity demanded rises or falls by a lesser % than the price c) An increase in price results in a increase in total revenue, demand is Inelastic d) When the demand is price inelastic, raising the price will increase revenue d.i)Elastic Demand – the quantity demanded rises or falls by a greater % than the price e) When demand is price elastic, even a small decrease can greatly increase revenue e.i) Inelastic Supply – the quantity supplied does not increase or decrease by as large a % as the price e.ii) Elastic Supply – the quantity supplied increases or decreases by a greater % than the price f) Graphically speaking if price and demand were a square box with the demand curve intersecting from top left downward to bottom right, the left half below the demand curve is price inelastic and the right half above the demand curve is elastic price

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g) SPLAT g.i)S ubstitutes – if there are substitutes, the demand is more elastic g.ii) P roportion of Income – the higher the price of the good, the more elastic g.iii) L uxury vs. Necessity – necessity (food) are inelastic “we have to have it”, while luxuries (sports cars) are elastic “we want it” g.iv) A ddictive – the more addictive a product is the more inelastic it is (cigarettes) g.v) T ime – the longer a consumer has to consider the purchase, the more elastic h) A Price - Quantity - L - graph with a straight HORIZONAL line in the middle is a graph that demonstrates perfectly elastic demand. h.i)A perfectly elastic demand is represented by a horizontal line h.ii) Slope = zero h.iii) If a good is perfectly elastic, even a small increase in price will cause the demand to drop to zero i) A Price - Quantity - L - graph with a straight VERTICAL line in the middle is a graph that demonstrates perfectly inelastic demand.
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