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Questions and Answers
Which statement accurately describes the relationship between price elasticity and revenue when demand is elastic?
How does the fallacy of composition apply to individual versus collective behaviors in economics?
Which factor contributes to a product being less elastic?
What happens to price elasticity of demand over time following a price change?
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What does cross-price elasticity of demand indicate?
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Which of the following statements accurately describes the relationship between goods and their cross-price elasticity of demand?
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In which scenario would a good be categorized as a luxury good based on income elasticity of demand?
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What happens to the price elasticity of supply over time as consumers adjust to price changes?
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Which statement is true regarding the characteristics of a good with a positive income elasticity of demand?
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What is the interpretation of a price elasticity of supply that is perfectly inelastic?
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Study Notes
Price Effect and Quantity Effect
- A price change has two effects:
- Price Effect: Revenue changes due to the new price per unit. A price cut lowers revenue, while a price increase raises it.
- Quantity Effect: Revenue changes due to the new quantity sold. More units sold increase revenue, while fewer sold decrease revenue.
Elasticity of Demand
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Elasticity of Demand: Determines which effect (price or quantity) is stronger when prices change.
- Elastic: Price increase decreases revenue (quantity effect is stronger)
- Inelastic: Price increase increases revenue (price effect is stronger)
- Unit-Elastic: Price changes have no effect on revenue (both effects offset each other)
Fallacy of Composition
- What's true for an individual might not be true for a group, and vice versa.
Short Run vs. Long Run Demand
- Elasticity varies with the time consumers have to adjust to a price change.
- Short-run elasticity is lower than long-run elasticity, as more substitutes are often available over a longer period
Factors Determining Price Elasticity of Demand
- Substitutes: Goods with few substitutes are less elastic
- Necessity vs. Luxury: Necessities are less elastic than luxuries
- Share of Income: Goods that make up a small portion of income are usually more elastic
- Time Since Price Change: Elasticity is higher immediately after a price change than further on
Cross-Price Elasticity of Demand
- Measures how the quantity demanded of one good reacts to a price change in another good
- Positive: Goods are substitutes. Increased price of one good leads to increased demand for the other.
- Negative: Goods are complements. Increased price of one good leads to decreased demand for the other.
- Close to zero: Goods are independent
Income Elasticity of Demand
- Measures how the quantity demanded of a good responds to a change in consumer income
- Positive: Normal good (demand increases with income)
- Negative: Inferior good (demand decreases with income)
- 0-1: Necessity
- Over 1: Luxury
Price Elasticity of Supply
- Measures how responsive the quantity supplied of a good is to a change in its price
- Always positive
- Zero: Perfectly inelastic supply (quantity supplied does not change with price)
- Infinite: Perfectly elastic supply (any increase in price leads to an infinite increase in quantity supplied).
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Description
This quiz covers the effects of price and quantity changes on revenue in economics. Explore the concepts of elasticity of demand and the fallacy of composition as they relate to short-run and long-run demand. Test your understanding of how these concepts shape market behavior.
