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Questions and Answers
What does a positive cross-price elasticity of demand indicate about two goods?
If a good has an income elasticity of demand between 0 and 1, how is that good categorized?
Which factor is NOT typically associated with a higher price elasticity of supply?
What does a negative income elasticity of demand signify about a good?
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What is the implication if the price elasticity of supply is perfectly inelastic?
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What is likely to happen to revenue if the price of an inelastic product is increased?
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Which of the following factors makes a product generally more elastic?
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How does the fallacy of composition relate to individual versus collective behavior in economics?
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What role does time play in the elasticity of demand?
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When is the total revenue maximized in the context of elasticity?
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Which statement best describes cross-price elasticity of demand?
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What typically happens to consumer behavior immediately after a price change?
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What is the primary reason that necessities have lower elasticity compared to luxuries?
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Study Notes
Price Elasticity of Demand
- Price Effect: Changes in revenue due to changes in unit price.
- Quantity Effect: Changes in revenue due to changes in the number of units sold.
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Elasticity of Demand: Determines which effect (price or quantity) dominates when the price changes.
- Elastic: Price increase reduces revenue, quantity effect is stronger.
- Inelastic: Price increase increases revenue, price effect is stronger.
- Unit-Elastic: Price changes do not affect revenue, both effects offset each other.
Fallacy of Composition
- What is true for an individual may not be true for everyone, and vice versa.
Short Run vs. Long Run
- Price elasticity of demand is higher in the long run due to increased time for consumers to adjust their spending patterns.
- Example: A rise in cigarette prices may not lead to immediate consumption reduction, but over a longer time, fewer people might begin smoking.
Factors Determining Price Elasticity of Demand
- Substitutes: Goods with fewer substitutes have lower elasticity.
- Necessity/Luxury: Necessities have lower elasticity than luxuries.
- Share of Income: Goods that constitute a small portion of income tend to have lower elasticity than those that constitute a larger portion, regardless of their actual cost. (e.g., 20% increase in chocolate price seems less impactful than a 20% increase in electricity price).
- Time Since Price Change: Elasticity is higher immediately after a price change than a long time after.
Cross-Price Elasticity of Demand
- Measures the relationship between the quantity demanded of one good and the price change of a different good.
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Calculation: % change in quantity of good A demanded / % change in price of good B
- Substitutes: Positive cross-price elasticity.
- Complements: Negative cross-price elasticity.
- Independent Goods: Zero or near-zero cross-price elasticity.
Income Elasticity of Demand
- Measures the responsiveness of quantity demanded to a change in income.
- Calculation: % change in quantity demanded / % change in income
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Budget Share: The proportion of total income spent on a specific good.
- Normal Goods: Positive income elasticity.
- Inferior Goods: Negative income elasticity.
- Necessities: Income elasticity between 0 and 1.
- Luxury Goods: Income elasticity greater than 1.
Price Elasticity of Supply
- Measures how responsive the quantity supplied of a good is to a change in its price.
- Calculation: % change in quantity supplied / % change in price
- Always Positive
- Perfectly Inelastic: Price elasticity of supply is 0.
- More elastic: Higher values of elasticity, potentially infinite.
Factors Determining Price Elasticity of Supply
- Availability of Inputs: Higher elasticity when inputs are readily available.
- Time: Elasticity increases as consumers have more time to adjust to price changes.
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Description
This quiz explores the concepts of price elasticity of demand, including the price effect, quantity effect, and the fallacy of composition. It also examines the differences between short-run and long-run elasticity and how consumer behavior changes over time. Test your understanding of these critical economic concepts.
