Elasticity in Economics
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Questions and Answers

A high cross elasticity of demand between two goods indicates that they are substitutes.

True (A)

Match the following types of elasticity with their corresponding definitions:

Income Elasticity = Measures how responsive the demand for a product is to changes in consumer income. Price Elasticity of Supply = The responsiveness of a supply of a good or service after a change in its market price. Cross Elasticity of Demand = An economic concept that measures how the price of one good affects the quantity demanded of another good.

What is the relationship between the price elasticity of demand, the price of a good, and the total revenue of a firm?

The price elasticity of demand determines the relationship between the price of a good and the total revenue of a firm.

What are the four factors that determine the price elasticity of demand?

<p>The four factors that determine the price elasticity of demand are the nature of the good, the availability of close substitutes, the share of the consumers' budget, and the passage of time</p> Signup and view all the answers

The higher the percentage that a product's price is of a consumer's income, the lower the elasticity of demand.

<p>False (B)</p> Signup and view all the answers

What are the two factors that determine the level of efficiency in an economy under perfect competition?

<p>The level of input resource allocation and the level of output produced. (C), The price of a good and the level of consumer satisfaction. (E)</p> Signup and view all the answers

What are the major limitations of perfect competition?

<p>Perfect competition is not a realistic model of the real world and has many limitations, particularly the assumption of numerous small firms, homogeneous products, perfect information, and free entry and exit.</p> Signup and view all the answers

A monopoly is a market structure where there is only one seller of a product that has no close substitutes.

<p>True (A)</p> Signup and view all the answers

What are some examples of barriers to entry in a monopoly?

<p>Examples of barriers to entry in a monopoly include legal restrictions, such as patents and government licenses, control of scarce resources, economies of scale, technological superiority, and deliberate attempts to erect barriers by existing firms.</p> Signup and view all the answers

A natural monopoly is an industry where a single firm can produce the entire output of the market at a lower average cost than multiple firms could.

<p>True (A)</p> Signup and view all the answers

Price discrimination occurs when a firm charges different prices to different customers for the same product even though the cost of supplying each customer is the same.

<p>True (A)</p> Signup and view all the answers

What are the three key differences between perfect competition and a monopoly?

<p>The three key differences between perfect competition and a monopoly are the monopolist's ability to set prices, the lack of substitutes for the monopolist's product, and the barriers to entry in a monopoly.</p> Signup and view all the answers

Monopsony occurs when there is a single buyer in a market.

<p>True (A)</p> Signup and view all the answers

Total profit is defined as the difference between sales revenue and total costs.

<p>True (A)</p> Signup and view all the answers

If a firm's economic profit is negative, then its decision-making is optimal.

<p>False (B)</p> Signup and view all the answers

A firm's total revenue is the amount received from sales after deducting all costs.

<p>False (B)</p> Signup and view all the answers

A firm maximizes profits when its economic profit is zero.

<p>True (A)</p> Signup and view all the answers

In a monopoly, the demand curve of the firm differs from the market demand curve.

<p>False (B)</p> Signup and view all the answers

Economic profit takes into account not only explicit costs but also implicit opportunity costs.

<p>True (A)</p> Signup and view all the answers

Total profit is considered an essential goal for a firm.

<p>True (A)</p> Signup and view all the answers

A firm's economic profit can only be positive or negative; it cannot be zero.

<p>False (B)</p> Signup and view all the answers

Under perfect competition, each firm is considered a 'price maker'.

<p>False (B)</p> Signup and view all the answers

A perfectly competitive firm can influence the market price by changing its output levels.

<p>False (B)</p> Signup and view all the answers

The presence of many small firms producing identical products increases competition in a market.

<p>True (A)</p> Signup and view all the answers

Perfect information means that all firms and customers are unaware of the prices set by competitors.

<p>False (B)</p> Signup and view all the answers

In a perfectly competitive market, firms can freely enter or exit without obstacles.

<p>True (A)</p> Signup and view all the answers

A variable cost for a firm is an expense that remains constant regardless of output levels.

<p>False (B)</p> Signup and view all the answers

The demand curve faced by a perfectly competitive firm is determined by the overall market conditions.

<p>True (A)</p> Signup and view all the answers

Different brands of toothpaste are considered homogeneous products.

<p>False (B)</p> Signup and view all the answers

If a good is a necessity, its elasticity is likely to be higher.

<p>False (B)</p> Signup and view all the answers

The demand for goods with many substitutes is typically inelastic.

<p>False (B)</p> Signup and view all the answers

As the duration of a price change increases, the elasticity of demand tends to decrease.

<p>False (B)</p> Signup and view all the answers

The broader the definition of a product, the higher the elasticity.

<p>False (B)</p> Signup and view all the answers

Marginal revenue is the addition to total revenue resulting from the increase of two units of output.

<p>False (B)</p> Signup and view all the answers

Complement goods experience an increase in demand when the price of one decreases.

<p>True (A)</p> Signup and view all the answers

Cross elasticity of demand measures how the price of one good affects the quantity demanded of a related good.

<p>True (A)</p> Signup and view all the answers

An output decision is optimal only when the corresponding marginal profit equals zero.

<p>True (A)</p> Signup and view all the answers

Perfect competition involves a market made up of numerous large firms producing differentiated products.

<p>False (B)</p> Signup and view all the answers

Market size has no effect on the demand for a product or service.

<p>False (B)</p> Signup and view all the answers

Consumer expectations can significantly alter current buying behavior.

<p>True (A)</p> Signup and view all the answers

Producer's surplus is defined as the difference between market price and marginal cost.

<p>True (A)</p> Signup and view all the answers

If marginal profit is negative, firms should increase their output.

<p>False (B)</p> Signup and view all the answers

Economic profit includes only explicit costs incurred by a firm.

<p>False (B)</p> Signup and view all the answers

In a perfectly competitive market, each firm can significantly influence market prices.

<p>False (B)</p> Signup and view all the answers

The marginal analysis for finding optimal output levels involves assessing if marginal profit is positive or negative.

<p>True (A)</p> Signup and view all the answers

Efficient allocation of resources ensures some individuals are made worse off.

<p>False (B)</p> Signup and view all the answers

In a planned economy, consumers have the freedom to choose their consumption.

<p>False (B)</p> Signup and view all the answers

Output selection involves deciding how much of each commodity should be produced.

<p>True (A)</p> Signup and view all the answers

Laissez-faire implies that the government should frequently intervene in market prices.

<p>False (B)</p> Signup and view all the answers

Central planners set production targets and sometimes dictate how firms should meet these targets.

<p>True (A)</p> Signup and view all the answers

The invisible hand uses prices to disrupt the organization of production in an economy.

<p>False (B)</p> Signup and view all the answers

Distribution is the question of how produced goods should be divided among consumers.

<p>True (A)</p> Signup and view all the answers

Efficiency is less critical when analyzing the economy as a whole compared to individual firms.

<p>False (B)</p> Signup and view all the answers

Sunk costs are considered to be a significant barrier to entry for industries due to large initial investments.

<p>True (A)</p> Signup and view all the answers

A monopoly must always consist of a large firm relative to the market demand.

<p>False (B)</p> Signup and view all the answers

Technical superiority can help maintain a monopolistic position in an industry.

<p>True (A)</p> Signup and view all the answers

Barriers to entry, such as legal restrictions, can encroach upon the public interest.

<p>True (A)</p> Signup and view all the answers

Monopolies operate with a supply curve like firms in perfect competition.

<p>False (B)</p> Signup and view all the answers

A monopolist can freely choose both the price and the quantity of their product.

<p>False (B)</p> Signup and view all the answers

Economies of scale can create a competitive advantage that leads to natural monopolies.

<p>True (A)</p> Signup and view all the answers

The primary reason for monopolistic markets is always related to the size of the firm.

<p>False (B)</p> Signup and view all the answers

Flashcards

Price Elasticity of Demand

The responsiveness of quantity demanded to a change in price.

Elastic Demand Curve

A percentage price change leads to a larger percentage change in quantity demanded.

Nature of the Good

Scarcity and usefulness of a good influence its price elasticity.

Availability of Substitutes

More substitutes, more elastic demand.

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Inelastic Demand Curve

A percentage price change leads to a smaller percentage change in quantity demanded.

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Share of Consumer Budget

Higher percentage of budget, more elastic demand.

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Time and Elasticity

Longer time, more elastic demand—people adjust.

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Total Revenue

Price x Quantity sold.

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Consumer Expenditure

Price x Quantity bought.

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Income Elasticity

How demand changes with income.

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Price Elasticity of Supply

Responsiveness of supply to price changes.

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Cross Elasticity of Demand

Responsiveness of demand for one good to price change in another good.

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Complements

Products used together; demand for one rises with the other.

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Substitutes

Products used in place of each other.

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Perfect Competition

Market structure with many small firms selling identical goods.

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Price Taker

Firm can't influence market price.

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Horizontal Demand Curve

Price doesn't change with quantity sold.

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Economic Profit

Total Revenue minus all costs (explicit and implicit).

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Variable Cost

Costs that depend on output.

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Marginal Cost

Extra cost to produce one more unit.

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Total Profit Maximization

Occurs where marginal cost equals marginal revenue.

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Monopoly

One supplier with no close substitutes.

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Monopsony

Single buyer in a market influencing price.

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Price Discrimination

Charging different prices to different customers.

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Barriers to Entry

Factors making it hard for new firms to enter a market.

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Substitute Goods

Products that can be used in place of each other because they are similar or serve the same purpose. For example, Pepsi and Coke.

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Complement Goods

Products that are used or consumed together. The demand for one increases when the price of the other decreases.

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Buyer's Income

The amount of money a consumer has to spend on goods and services.

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Price of Substitute Goods

Goods or services that can be used instead of other goods or services. Ex: Pepsi and cola.

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Market Size

The total potential demand for a product or service in a given market.

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Consumer Tastes

The popularity of a good or service. It has a strong effect on the demand for it.

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Consumer Expectations

What you expect prices to do in the future can influence your current buying habits.

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Average Revenue (AR)

Total revenue divided by the quantity sold. It represents the average price per unit sold.

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Marginal Revenue (MR)

The additional revenue generated by selling one more unit of a product.

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Marginal Profit

The additional profit generated by selling one more unit.

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Producer's Surplus

The difference between the market price of a good and the minimum price the seller would accept for it.

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Optimal Output Level

The production level where marginal profit is zero, maximizing total profit.

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Marginal Rule for Maximizing Total Profit

Increase output if marginal profit is positive, decrease output if marginal profit is negative, and stop at zero marginal profit.

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Total Profit

The difference between a company's revenue (sales) and its total costs (expenses).

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Why is economic profit important for decision making?

A positive economic profit indicates the firm's resources are being used more efficiently than in any other alternative use. A zero economic profit means the firm is doing as well as it could in any other use. A negative economic profit suggests the resources are not being used optimally and there are better alternatives.

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Total Revenue (TR)

The total amount of money a supplier firm receives from sales without deducting any costs.

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Optimal Decision Making

When a firm chooses the best possible use of its resources, resulting in maximizing its economic profit.

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What does it mean if a firm is not maximizing its profits?

If a firm's economic profit is negative, even after they maximize their profits from selling their output, it means there's a better alternative use of their resources that would bring higher profits.

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Why is total profit a firm's assumed goal?

Total profit is the primary objective of many businesses, as it represents the net financial gain from their operations.

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What is opportunity cost?

The value of the best alternative forgone when making a choice.

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Homogeneous Product

A product that is identical regardless of the seller. For example, No. 1 red winter wheat is homogeneous, but different brands of toothpaste are not.

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Supply Curve

A graphical representation showing the relationship between the price of a good and the quantity that firms are willing to supply.

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Marginal Revenue

The additional revenue gained from selling one more unit of a product.

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Perfect Information

Buyers and sellers have complete knowledge of all product prices and qualities.

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Efficient Resource Allocation

Using resources in a way that maximizes benefits for individuals without harming others.

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Scarcity and Coordination

The limited availability of resources means we need a system to organize how those resources are used.

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Laissez-faire

A system where the government minimally intervenes in the economy, relying on free markets to allocate resources.

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Output Selection

Deciding how much of each good to produce, considering limited resources.

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Production Planning

Determining how much of each input to use to produce each good.

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Distribution

Deciding how the produced goods are distributed among consumers.

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Centralized Planning

A system where a central authority sets production targets and directs resource allocation.

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Invisible Hand

The idea that prices in a free market, without government intervention, naturally guide efficient resource allocation.

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What discourages entry into an industry?

A large upfront investment that cannot be recovered, known as a sunk cost, acts as a significant barrier to entry for new firms.

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What is technical superiority?

When a firm possesses superior technological know-how compared to potential competitors, it can enjoy a temporary monopoly.

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What are economies of scale?

A situation where larger firms have a cost advantage over smaller rivals due to their size.

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What is a natural monopoly?

An industry where a single firm can produce the entire market output at a lower average cost than multiple smaller firms.

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What are the two reasons for a monopoly?

Barriers to entry, such as legal restrictions and patents, and cost advantages of superior technology or large-scale operation.

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Why is a monopoly firm not a 'price taker'?

A monopoly firm has the power to set its own price instead of accepting the market price, unlike firms in perfect competition.

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What is a monopolist's supply decision?

A monopolist firm chooses the price and quantity combination on the demand curve that maximizes its profits because it is not constrained by a market price.

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Why are barriers to entry considered against public interest?

Barriers to entry can lead to higher prices and reduced consumer choice, which are generally considered undesirable.

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Study Notes

Elasticity

  • Elasticity measures responsiveness
  • High cross elasticity of demand indicates goods competing in the same market, preventing a supplier from controlling price
  • Price elasticity of demand is the ratio of percentage change in quantity demanded to percentage change in price
  • Elastic demand curve: large percentage change in quantity demanded for a small percentage change in price
  • Inelastic demand curve: small percentage change in quantity demanded for a large percentage change in price

Factors affecting price elasticity of demand

  • Nature of the good: Necessity (low elasticity) vs. luxury (high elasticity); scarcity (low elasticity)
  • Availability of substitutes: Many substitutes (high elasticity)
  • Share of consumer's budget: Higher percentage of budget (high elasticity)
  • Passage of time: Longer time horizon (high elasticity)

Elasticity as a general concept

  • Income elasticity: measures demand responsiveness to income changes
  • Price elasticity of supply: measures supply responsiveness to price changes
  • Cross elasticity of demand: measures how one good's price affects the quantity demanded of another good
    • Substitutes: higher cross elasticity, as price change easily switches demand
    • Complements: lower cross elasticity, as goods are consumed together

Effect on total revenue and expenditure

  • Revenue = quantity sold × price
  • Expenditure = quantity purchased × price
  • Customer expenditure equals firm revenue

Other concepts

  • Complements: Goods consumed together (e.g., cars and gasoline)
  • Substitutes: Goods replacing each other (e.g., Pepsi and Coke)
  • Buyer's income: Consumer spending power affects demand
  • Price of substitute goods: Availability of similar goods affects demand
  • Market size: Total demand for a product or service
  • Consumer tastes: Shifts in popularity influence demand
  • Consumer expectations: Future price predictions affect current demand
  • Technology: Advancements can increase efficiency; increase supply, decrease costs
  • Government action: Taxes or subsidies impact production costs; can affect production of goods
  • Number of sellers: More sellers, greater supply; fewer sellers, less supply
  • Producer expectations: Future price trends impact current supply

Week 6

  • Marginal Analysis: optimal decision making based on the addition of one more unit of output

Week 7

  • Perfect Competition: Market with numerous small firms, homogeneous products, free entry/exit
  • Perfect Competition Characteristics
    • Many buyers and sellers
    • Homogeneous products
    • Free entry and exit
    • Perfect information

Week 9

  • Monopoly: Single seller in a market, no close substitutes, barriers to entry
  • Monopsony: Single buyer in a market, no close alternatives, unique product

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Description

This quiz explores the concept of elasticity in economics, focusing on price elasticity of demand, cross elasticity, and factors influencing these metrics. It covers the distinctions between elastic and inelastic demand curves and how various factors such as necessity and availability of substitutes affect elasticity.

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