AP Microeconomics Review #2 Stater April 11, 2019

Elasticity Elasticity of Demand; Other Measures of Elasticity; Total Revenue Test; Elasticity of Supply

Elasticity of Demand Measures consumer responsiveness to a price change Ed = % change in Qd / % change in P Ed > 1 means relatively elastic demand Ed = 1 means unit elastic demand Ed < 1 means relatively inelastic demand

Elasticity of Demand – Midpoint Formula Used to calculate elasticity of demand when given price & quantity data at two separate prices Ex: when given two points on a demand curve

Determinants of Elasticity of Demand Substitutability The more subs available, the more elastic the demand Proportion of income The larger the portion of income a product consumes, the more elastic the demand Luxuries v. Necessities Luxuries are more elastic than necessities Time The more time you have to buy something, the more elastic the demand

Total Revenue Test TR = Price x Quantity If price increases and TR decreases, or if price decreases and TR increases, the demand is elastic at that price range. If price increases and TR increases, or if price decreases and TR decreases, the demand is inelastic at that price range. Unit elastic – price changes and TR remains constant

Cross-price Elasticity of Demand Exy = % change in Qd of good X / % change in P of good y Exy > 0 (positive) means the goods are substitutes Exy < 0 (negative) means the goods are complements

Income Elasticity of Demand Ei = % change in Qd / % change in income Ei > 0 (positive) means the good is normal Ei > 1 means the good is normal & a luxury Ei < 0 (negative) means the good is inferior

Elasticity of Supply Es = % change in Qs / % change in price Es > 1 means relatively elastic supply Es = 1 means unit elastic supply Es < 1 means relatively inelastic supply

Elasticity of Supply – time periods Market Period Immediate time period (shortest) Perfectly inelastic supply Short Run Can only change variable inputs, not plant size More elastic than market period Long Run Can change all inputs Most elastic

Price Controls, Excise Taxes, & Trade Barriers Graphical Analysis; Effect on Producer & Consumer Surplus; Government Revenue; Effects on Efficiency

Excise Tax Per-unit tax on the production of a good To decrease consumption or collect gov’t revenue Shifts the supply curve vertically by amount of the tax

Excise Tax Results in gov’t revenue = Per-unit Tax Amount X Q Affects CS & PS Results in deadweight loss (DWL) Net benefit lost to society due to a movement away from allocative efficiency

Excise Tax Pre-tax: CS = ABCF PS = DEG Post-tax: Per-unit tax = $2 Gov’t revenue = BCD CS = A PS = E DWL = F&G

Excise Taxes & Elasticity The party that is least equipped to respond faces the larger tax burden or incidence. If supply is more elastic than demand, consumers face the higher burden If demand is more elastic than supply, producers face the higher burden If demand is perfectly inelastic, the burden is entirely on consumers in the form of a higher price. If demand is perfectly elastic, the burden is entirely on producers to cover the tax.

Subsidies Payments made by the government to a firm for producing a product or service deemed needed by society Ex: Education, Prescription Drug Shifts supply curve to the right Higher quantity produced; lower cost to consumers

Price Controls (discussed in Review #1) Know how to analyze effects on CS, PS, & DWL No gov’t revenue In this example: ABC is consumer surplus before the price floor; A is after DEF is producer surplus before the price floor; BDF is after C&E become DWL after the price floor

Price Controls (discussed in Review #1) In this example: ABC is consumer surplus before the price ceiling; ABD is after DEF is producer surplus before the price ceiling; F is after C&E become DWL after the price ceiling

International Trade Import: Goods we get from abroad Revenue tariff: excise tax levied on an import NOT produced in the domestic market (ex: bananas) Protective tariff: excise tax levied on an import that IS produced in the domestic market (ex: steel) Import quota: a maximum amount of a good that can be imported into the domestic market Directly affects quantity

International Trade Trade barriers result in inefficiency & DWL Tariffs also result in gov’t revenue (not quotas) CS & PS are affected https://www.youtube.co m/watch?v=zhD--UeRiOI

Theory of Consumer Choice Marginal Analysis; Law of Diminishing Marginal Utility; Utility Maximization

Key Terms Utility – happiness/satisfaction Measured in utils – “happy points” Total utility – combined satisfaction at a given quantity of product consumed Marginal utility – additional satisfaction gained from consuming an additional unit You must add the MU from each previous quantity to get the TU at a given quantity

Law of Diminishing Marginal Utility In a given time period, the additional satisfaction from consuming one more of something falls. The unconstrained consumer (no price or income restraints), will still rationally stop consuming something when MB = MC, and before MB < MC.

Utility-Maximizing Rule Marginal utility per dollar (MU / P) Allows us to compare the amount of extra utility gained from differently priced goods (putting in “like terms”) To maximize utility, find the combination of quantities that satisfies both conditions: The ratios of MU / P for each of two products must be equal. All income must be spent without going over.