EC4101 week 4 lecture 2

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Questions and Answers

What type of goods are indicated by a positive cross-price elasticity of demand?

Substitute goods (correct)

Luxury goods

Complimentary goods

Independent goods

Which scenario represents a good with an income elasticity of demand between 0 and 1?

A luxury item that sees substantial demand increase with income rise

An inferior good that is purchased less as income increases

A basic necessity that consumers will buy even when incomes fall

A normal good where demand increases at a lesser rate than income (correct)

What is indicated by a price elasticity of supply that is perfectly inelastic?

The quantity supplied can change infinitely with price changes

The quantity supplied does not respond to price changes (correct)

The quantity supplied varies linearly with price changes

The quantity supplied responds significantly to price changes

Which factor would most likely increase the price elasticity of supply over time?

More time allowed for producers to adjust their supply Signup and view all the answers

What is the defining characteristic of a good classified as an inferior good?

Demand decreases with rising consumer income Signup and view all the answers

What is the primary reason a price increase results in decreased revenue when demand is elastic?

The quantity effect outweighs the price effect. Signup and view all the answers

In which scenario is price elasticity of demand expected to be less in the short run compared to the long run?

When consumers lack immediate substitutes for a product. Signup and view all the answers

Which factor influences the price elasticity of demand by determining whether a good is perceived as essential or non-essential?

The necessity versus luxury distinction. Signup and view all the answers

How does the fallacy of composition relate to price elasticity of demand?

It suggests that market-wide effects can be misinterpreted based on individual behavior. Signup and view all the answers

What happens to the price elasticity of demand just after a price change?

It tends to be more elastic immediately following the change. Signup and view all the answers

Which of the following best describes cross-price elasticity of demand?

It evaluates how demand for one good changes when the price of a different good changes. Signup and view all the answers

What effect does a price cut have on revenue when demand is inelastic?

It decreases total revenue. Signup and view all the answers

How would a 20% price increase affect the demand for a good perceived as a necessity?

Demand would remain nearly unchanged due to its essential nature. Signup and view all the answers

Study Notes

Price and Quantity Effects

A price change has two effects:
- Price effect: Revenue changes based on the new price for each unit sold.
- Quantity effect: Revenue changes based on the number of units sold after a price change.
Elasticity of demand determines which effect is more significant.
- Elastic: Price increase reduces revenue (quantity effect stronger).
- Inelastic: Price increase increases revenue (price effect stronger).
- Unit-elastic: Price changes do not affect revenue (effects cancel each other).

Fallacy of Composition

What's true for an individual isn't necessarily true for everyone collectively, and vice versa.

Short Run vs. Long Run

Price elasticity of demand varies with the time consumers have to adjust their spending.
Short-run elasticity is lower; consumers have less time to substitute.
Long-run elasticity is higher; consumers have more time to substitute.
- Example: A price increase in cigarettes might not immediately reduce consumption, but eventually, fewer people might start smoking.

Factors Determining Price Elasticity of Demand

Substitutes: Goods with few substitutes are less elastic.
Necessities vs. Luxuries: Necessities are less elastic than luxuries.
Share of income spent: Goods that represent a smaller share of income are usually less elastic.
Time since price change: Elasticity is higher immediately after a price change and decreases over time.

Cross-Price Elasticity of Demand

Measures how responsive the quantity demanded of one good is to changes in the price of another good.
Positive cross-price elasticity: Goods are substitutes.
Negative cross-price elasticity: Goods are complements.
Zero or close to zero cross-price elasticity: Goods are independent.

Income Elasticity of Demand

Measures how responsive the quantity demanded of a good is to changes in consumer income.
Positive income elasticity: Normal good (demand increases with income).
Negative income elasticity: Inferior good (demand decreases with income).
Between 0 and 1: Necessity
Greater than 1: Luxury

Price Elasticity of Supply

Measures how responsive the quantity supplied of a good is to changes in the price of that good.
Always positive.
Perfectly inelastic: Quantity supplied does not change with price.
Perfectly elastic: Quantity supplied changes significantly, even with small price changes.

Factors Determining Price Elasticity of Supply

Availability of inputs: Higher availability, higher elasticity.
Time: Longer time period, higher elasticity, more time for producers to adjust.

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Description

This quiz covers the concepts of price and quantity effects in economics, focusing on elasticity of demand. Understand the differences between elastic, inelastic, and unit-elastic demand, and explore the fallacy of composition and distinctions between short run and long run elasticity. Test your knowledge on these critical economic principles and their applications.