Econ 11

Introduction to Microeconomics

Fred E. Foldvary

Chapter 5, Mankiw, Elasticity

*Note: these notes below are very rough and not so well organized.*

Elasticity: a confusing term meaning responsiveness.

price elasticity of demand. (q demanded)

responsiveness of quantity demanded to a change in price.

Measured as change in Q / Q, divided by change in P / P.

price elasticity of supply (q supplied).

The responsiveness of the quantity supplied to a change in p.

percentage change in Q supplied to a percentage change in p.

Demand elastic if price elasticity is high.

Inelastic if elasticity is low.

Quantity not responsive to price change.

What is revenue? How calculated? Price * quantity. Revenue = P * Q.

Elastic: Q change more than P change: R up if P down.

Inelastic: Q change less than P: R down if P down.

Unit Elastic: no change in R.

Elasticity of .5 means? Q demand increases. by ½ % if P down 1%. Perfectly

inelastic, elastic.

why important? Business wants to know effects of p change.

grocery store hires economic consultant: elasticity dm for bananas.

possible term paper: measure the elasticity of some goods.

what is the p elasticity of changes in univ tuition?

Straight-line demand curve.

Does the elasticity remain the same?

elastic at top, inelastic at bottom

Demand elastic when there are substitutes.

Demand less elastic short run than long run.

Income elasticity of demand:

responsiveness of quantity demanded to changes in income

Normal good: increase in income causes demand to rise

Inferior good: increase in income causes less demand.

Cross elasticity of demand: the responsiveness of the quantity demanded of

one good when the price of another good changes.

Substitutes: cross elasticity is positive.

Complements: negative.

If the cross price elasticity is zero, then there is no relationship between the

two goods.

What is a substitute? & Y. increase of price in => more of Y

demanded. Demand curve for Y shifts up, to the right.

Perfect substitute: don't care which one you get.

Complements: goods which go together. Computers & software.

Blackboard & chalk. Cream & coffee. Bread & butter.

Perfect complement: price of one goes up, Q of the other =.

Right & left shoes. Left ones free. Take any?

Normal good: dm curve shifts out when incomes rise.

Inferior goos: dm curve shifts down as income rises. Good from a thrift

shop.

Superior goods: % change quantity goes up more than income. Gourmet

food.

Marginal utility determines amounts bought:

MU1/P1 = MU2/P2, P>0

consumer equilibrium. P=0 : positive marginal utility.

Substitution & income effects. Giffen good.

Law of demand holds only for substitution.

consumer surplus: paying less than the maximum.

Example of perfect complements: blue and red socks. Price of blue one goes down.

change in demand, blue & red?

Suppose cost of production zero,

straight line demand. What quantity, maximum profit?

Demand curve: income and substitution effects.

Elasticity: effect of a sales tax

Highly responsive to price: quantity demanded much reduced.

Producer bears the burden.

Not responsive: consumer bears the burden.

Substitutes: Price of up, demand for Y up.

Complements: Price of up, demand for Y down.

Perfect substitutes: price of up, al demand to Y.

Perfect complements: ratio of and Y fixed.

Suppose you have $5 gift certificate for a salad bar. Only 2 items: corn and

beans. You like both. Corn: 50c per pound. Beans $1 per pound. Can get

10 lb corn or 5 lb beans, or combination. Straight line. If price changes,

budget line changes. Suppose you first only bought corn. 10 lb. How much

corn would you give up to get 1 lb beans.

More on indifference curves:

Marginal rate of substitution = slope.

If perfect substitutes, indifference curve straight line.

If perfect complements, indifference curve L-shaped.

Normally, a curve. Diminishing marginal utility.

Get indifference curve.

Slope is the marginal rate of substitution.

Perfect substitutes: -1.

Perfect complements: 0 or infinity.

Curve is concave from above, bowed inward.

Indifference curves do not cross.

Indifference curve tangent to budget line determines consumption.

Marginal utilities divided by price are equal

As one price changes, quantities change.

Can derive demand curve.

A "bad" is a commodity a consumer dislikes.

Suppose pizza has pepperoni and anchovies; you don't like anchovies.

Indifference curves have positive slope.

The direction of increasing preference is down and to the right.

A neutral good is one which you don't care about either way.

Indifference curves are vertical

Satiation: an optimal combination.

Indifference curves surround the point.