ECON_CH 5 & 6

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Questions and Answers

What effect does a price cut have on a product with inelastic demand?

It increases total revenue

It has no effect on total revenue

It reduces total revenue (correct)

It makes the demand curve more elastic

Which of the following factors affects demand elasticity?

The brand name of the product

The color of the product

The shape of the product

The availability of substitutes (correct)

What type of goods tend to have relatively elastic demand?

Luxuries (correct)

Necessities

Food items

Electronics

What happens to demand in the longer run?

It becomes more elastic Signup and view all the answers

What is the income elasticity of demand?

A measure of the responsiveness of demand to changes in income Signup and view all the answers

What is the difference between short-run and long-run demand elasticity?

Long-run demand elasticity is more responsive to price changes Signup and view all the answers

What drives the difference between short-run and long-run elasticities?

The time dimension Signup and view all the answers

What is the formula for calculating percentage change in quantity demanded?

((Q2 - Q1) / Q1) * 100% Signup and view all the answers

What is the definition of point elasticity?

A measure of elasticity that uses the slope measurement. Signup and view all the answers

What is the formula for point elasticity of demand?

(ΔQ / Q1) / (ΔP / P1) Signup and view all the answers

What does ΔQ represent in the formula for point elasticity of demand?

A small change in quantity demanded Signup and view all the answers

What is the reciprocal of the slope in the context of point elasticity of demand?

ΔP / ΔQ Signup and view all the answers

What is the purpose of calculating point elasticity of demand?

To measure the responsiveness of quantity demanded to a change in price Signup and view all the answers

What is the relationship between point elasticity of demand and the slope of the demand curve?

Point elasticity of demand is the reciprocal of the slope of the demand curve Signup and view all the answers

What is the concept used to quantify the response in one variable when another variable changes?

Elasticity Signup and view all the answers

What does the price elasticity of demand measure?

The responsiveness of quantity demanded to changes in price Signup and view all the answers

Why is the slope of a demand curve not a useful measure of responsiveness?

Because it changes when the unit of measure is changed Signup and view all the answers

What is the term for demand in which quantity demanded does not respond at all to a change in price?

Perfectly Inelastic Demand Signup and view all the answers

What is the formula for the elasticity of A with respect to B?

%ΔA / %ΔB Signup and view all the answers

What is the term for demand in which quantity demanded drops to zero at the slightest increase in price?

Perfectly Elastic Demand Signup and view all the answers

What is the purpose of the concept of elasticity in economics?

To measure the responsiveness of quantity demanded to changes in price Signup and view all the answers

What is the elasticity of demand between points C and D?

-0.294 Signup and view all the answers

What is the formula for total revenue received by producers?

TR = P × Q Signup and view all the answers

What happens to quantity demanded when price increases?

Quantity demanded decreases Signup and view all the answers

What is the effect of a price increase on total revenue when demand is inelastic?

Total revenue increases Signup and view all the answers

What is the effect of a price increase on total revenue when demand is elastic?

Total revenue decreases Signup and view all the answers

What is the effect of a price cut on total revenue when demand is elastic?

Total revenue increases Signup and view all the answers

What is the relationship between the percentage change in price and the percentage change in quantity demanded when demand is inelastic?

The percentage change in price is greater than the percentage change in quantity demanded Signup and view all the answers

What is the relationship between the percentage change in price and the percentage change in quantity demanded when demand is elastic?

The percentage change in price is less than the percentage change in quantity demanded Signup and view all the answers

What determines whether total revenue rises or falls in response to a price increase?

The elasticity of demand Signup and view all the answers

What happens to the labor supply curve when the income effect outweighs the substitution effect?

It slopes downward Signup and view all the answers

How does an increase in the interest rate affect household saving behavior?

Saving increases due to the substitution effect Signup and view all the answers

What is the term for the complex set of institutions in which households and firms interact to allocate financial capital?

Financial capital market Signup and view all the answers

What is the term for the graph that shows the different combinations of goods and services that a household can afford to buy?

All of the above Signup and view all the answers

What is the law that states that as the quantity of a good consumed increases, the marginal utility derived from each additional unit will eventually decrease?

Law of diminishing marginal utility Signup and view all the answers

What is the term for the decision-making process by which households allocate their limited income among various goods and services?

Utility-maximizing rule Signup and view all the answers

What is the primary assumption about household knowledge in the market system?

They possess a knowledge of the qualities and prices of everything available in the market. Signup and view all the answers

In a perfectly competitive industry, what is the characteristic of the products produced?

They are identical to or indistinguishable from one another. Signup and view all the answers

What is the role of households in the circular flow diagram?

They demand output in output markets and supply labor and capital in input markets. Signup and view all the answers

What is the purpose of building from the ground up in understanding the microeconomy?

To understand how the economy works. Signup and view all the answers

What is the assumption about the industry structure in perfect competition?

There are many firms, each being small relative to the industry. Signup and view all the answers

What is the role of government in the microeconomy, according to the circular flow diagram?

It is not included in the circular flow diagram. Signup and view all the answers

What is the opportunity cost of consuming one hour of leisure?

The wage rate Signup and view all the answers

What determines the shape of the labor supply curve?

How households react to changes in the wage rate Signup and view all the answers

What trade-off do households face when deciding whether to enter the workforce?

Wages and leisure Signup and view all the answers

What is the term for the curve that shows the quantity of labor supplied at different wage rates?

Labor supply curve Signup and view all the answers

What is the primary focus of Chapters 6-8 in the context of economics?

Household and firm decision making in simple, perfectly competitive markets Signup and view all the answers

What happens to the labor supply curve when the substitution effect outweighs the income effect?

It slopes upward Signup and view all the answers

What is the theme that runs through the analysis of household decision making in the product and labor markets?

The concept of constrained choice Signup and view all the answers

What is the limiting factor that affects household members' labor supply decision?

The limit of 168 hours in a week Signup and view all the answers

What are the three basic decisions that every household must make?

How much of each product to demand, how much labor to supply, and how much to spend today Signup and view all the answers

What is the primary focus of Chapter 12 in the context of economics?

Linking perfectly competitive markets with a discussion of market imperfections and the role of government Signup and view all the answers

What is the consequence of reallocating time between work and nonwork activities?

Households give up one hour's wages Signup and view all the answers

What topics are covered in Chapters 13-19?

Monopoly, monopolistic competition, oligopoly, externalities, public goods, uncertainty and asymmetric information, and income distribution Signup and view all the answers

What is the relationship between the chapters on perfectly competitive markets and the chapters on noncompetitive market structures?

The chapters on perfectly competitive markets are a prerequisite for understanding noncompetitive market structures Signup and view all the answers

Study Notes

Elasticity of Demand

Elasticity is a measure of the responsiveness of demand to changes in price or other influential factors.
The formula for price elasticity of demand is: %change in quantity demanded / %change in price.
Elasticity is a general concept used to quantify the response in one variable when another variable changes.

Determinants of Demand

Availability of substitutes: the more substitutes available, the more elastic the demand.
Luxuries versus necessities: luxury goods tend to have relatively elastic demand, while necessities have inelastic demand.
The time dimension: in the longer run, demand is likely to become more elastic.

Income Elasticity of Demand

Income elasticity of demand is a measure of the responsiveness of demand to changes in income.
The formula is: %change in quantity demanded / %change in income.

Point Elasticity

Point elasticity is a measure of elasticity that uses the slope measurement.
The formula is: ΔQ / Q1 ÷ ΔP / P1.

Elasticity and Total Revenue

Total revenue is the product of price and quantity: TR = P × Q.
When price increases, quantity demanded decreases, and vice versa.
When demand is inelastic, a price increase increases total revenue, but a price cut reduces total revenue.
When demand is elastic, a price increase reduces total revenue, but a price cut increases total revenue.

Types of Elasticity

Perfectly inelastic demand: quantity demanded does not respond at all to a change in price.
Perfectly elastic demand: quantity demanded drops to zero at the slightest increase in price.

Graphical Representation

The graph shows the relationship between the demand curve and the elasticity of demand.
Point elasticity changes along a demand curve.
The slope of the demand curve is not a useful measure of responsiveness.

Household Behavior and Consumer Choice

The chapter focuses on understanding household decisions in the product market and labor market.
The concept of constrained choice is a central theme in this analysis.

Assumptions

Two key assumptions are made:
- Perfect knowledge: households possess knowledge of product qualities and prices, and firms have all available information regarding wages, capital costs, technology, and output prices.
- Perfect competition: an industry structure where many firms produce virtually identical products, and no firm is large enough to control prices.

Firm and Household Decisions

Households demand output in output markets and supply labor and capital in input markets.
Figure II.1 illustrates the circular flow diagram, which excludes the government and international sectors for simplicity.

Understanding the Microeconomy and the Role of Government

The chapter lays the foundation for understanding how the economy works, with a focus on household behavior and firm decisions.

Saving and Borrowing

Changes in interest rates affect household behavior in capital markets.
Empirical evidence suggests that saving tends to increase as the interest rate rises.

Key Concepts

Budget constraint: the limit on a household's spending based on its income and prices.
Choice set or opportunity set: the set of goods and services a household can afford to buy.
Financial capital market: the system where suppliers of capital (households) and demanders of capital (firms) interact.
Homogeneous products: undifferentiated outputs that are identical to or indistinguishable from one another.
Labor supply curve: a curve showing the quantity of labor supplied at different wage rates.
Law of diminishing marginal utility: the idea that the additional utility gained from consuming one more unit of a good decreases as the quantity consumed increases.
Marginal utility (MU): the additional utility gained from consuming one more unit of a good.
Perfect competition: an industry structure where many firms produce virtually identical products, and no firm is large enough to control prices.
Perfect knowledge: the assumption that households possess knowledge of product qualities and prices, and firms have all available information regarding wages, capital costs, technology, and output prices.
Real income: the purchasing power of a household's income.
Total utility: the total satisfaction gained from consuming a certain quantity of a good.
Utility: the satisfaction gained from consuming a good or service.
Utility-maximizing rule: the principle that households make decisions to maximize their overall satisfaction.

Chapter Overview

Chapters 6-8 focus on household and firm decision making in simple, perfectly competitive markets.
Chapters 9-11 analyze how firms and households interact in output markets and input markets to determine prices, wages, and profits.
Chapter 12 discusses market imperfections and the role of government.
Chapters 13-19 cover noncompetitive market structures, externalities, public goods, uncertainty, and income distribution.

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Description

This quiz covers the concept of elasticity of demand, including how it's affected by price cuts and availability of substitutes. Test your understanding of elastic and inelastic demand.