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What is the Law of Demand?
The rule that, holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase, and when the price of a product rises, the quantity demanded of the product will decrease. Price Up = Qty Demand Down Price Down = Qty Up
What are the 5 Factors that affect Demand?
- Consumer Income
- Price of Related Goods
- Consumers' Expectations
- Consumers' Tastes & Preferences
- Number of Buyers
Explain the difference between a shift in the demand curve vs. a movement along the demand curve.
A shift of a demand curve is an increase or a decrease in demand. A movement along a demand curve is an increase or a decrease in the quantity demanded.
What is the difference between a normal good and an inferior good?
A good is a normal good when demand increases following a rise in income and decreases following a fall in income. A good is an inferior good when demand decreases following a rise in income and increases following a fall in income.
When are two goods substitutes, and when are they complements?
Two goods are substitutes when the more you buy of one, the less you buy of the other. They are complements when the more you buy of one, the more you buy of the other.
What is the Law of Supply?
The rule that, holding everything else constant, increases in price cause increases in the quantity supplied, and decreases in price cause decreases in the quantity supplied.
What are 4 Factors that affect Supply?
- Prices of Inputs
- Technological Change
- Number of Firms in the Market
- Expected Future Prices
When does a Surplus occur?
When the Market Price is HIGHER than Equilibrium price.
When does a Shortage occur?
When Market Price is LOWER than Equilibrium price.
What do firms do to reduce surplus?
They Decrease Price to Increase Demand and decrease Surplus.
What do firms do to eliminate Shortage?
They must increase the price to reduce the demand and match the supply.
What information does Elasticity Value provide?
- Type of the demand of the good: elastic, inelastic or unit-elastic.
- Type of the supply of the good: elastic, inelastic or unit-elastic.
- Type of the good: Normal or Inferior.
- Relationship between two goods: Compliments or Substitutes.
What is the equation used to determine Elasticity?
= (%Change in Qty Demanded) / (%Change in Price)
When is Demand Elastic?
- When the % change in qty demanded is greater than the % change in price. ED>1 (absolute value of -1)
- * Small increase in price = Large decrease in qty demanded
When is Demand Inelastic?
- When the % change in qty demanded is less than the % change in price. ED<1 (in absolute value)
- * Large Increase in Price = Small decrease in qty demanded.
- ***Inelastic Goods are goods we CAN NOT LIVE WITHOUT! (ex. Gas)
When is Demand Unit-Elastic?
- When the % change in quantity demanded is equal to the % change in price. ED=1 (in absolute value)
- *Equal degree of change between price & qty demanded.
What is Total Revenue, and how is it calculated?
Total Revenue is the total amount of funds received by a seller of a good or service, calculated by multiplying price per unit by the number of units sold.
What effect does price have on a firm's total revenue with elastic goods?
If Price goes up a little, qty demanded goes down 2x as much and total revenue decreases.
What effect does price have on a firm's total revenue with inelastic goods?
If Price goes up a lot, Qty demanded only goes down a little and total revenue increases.
What effect does price have on a firm's total revenue with unit-elastic goods?
If Price goes up a little, Qty demanded goes down a little, and Total Revenue is left unchanged.
What is Cross-Price Elasticity of Demand, and how is it calculated?
- The Cross-Price Elasticity of Demand gives us an idea of the relationship between goods X and Y.
- (%change in qty demanded of X) / (%change in price of Y)
- If result is:
- Positive - the products are Substitutes
- Negative - the products are Complements
- Zero - the products are Unrelated
What is Income Elasticity of Demand, and how is it calculated?
- Income Elasticity of Demand measures the responsiveness of qty demanded to changes in income.
- = (%change in qty demanded) / (%change in income)
- If result is:
- Positive but less than 1 - then the good is normal and a necessity
- Positive and greater than 1 - the good is normal and a luxury
- Negative - the good is inferior
What is the Price Elasticity of Supply, and how is it calculated?
- The Price Elasticity of Supply measures how much the qty supplied increases when price increase.
- = (%change in qty supplied) / (%change in price) [ES is always positive!]
- If ES > 1 then supply is Elastic.
- If ES = 1 then supply is Unit-Elastic
- If ES < 1 then supply is Inelastic.
What is the Midpoint Formula?
- (Q2 - Q1) (P2 - P1)
- ________ / _________
- (Q2 +Q1) (P1 + P2)
- ________ _______
- 2 2
What are the key determinants for a product's Price Elasticity of Demand?
- Availablity of Substitutes
- Passage of Time
- Necessities vs. Luxuries
- Definition of the Market
- Share of the Good in the Consumers' Budget