Notes for a freshmen college microeconomics course.

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CHAPTER 20

DEMAND AND SUPPLY ELASTICITY

I. Price Elasticity of Demand

A. Concept of Price Elasticity

The responsiveness or sensitivity of quantity

demanded to a change in price.

B. General Formula for Price Elasticity

Percentage change in quantity demanded

Percentage change in price

C. Mid-Points Formula

E/demand =

D. Interpreting the Elasticity Coefficient

A coefficient higher than 1 is elastic

" " lower " 1 is inelastic

" " exactly 1 is unitary

A negative coefficient implies that a lower

price results is lower quantities sold.

E. Extreme Elasticities

Perfectly Elastic Perfectly Inelastic

Demand or Supply Demand or Supply

II. Total Revenue Test

If Demand is Elastic If Demand is Inelastic

P TR P TR

P TR P TR

III. What Determines Price Elasticity

A. The number and quality of substitute goods.

B. The proportion of income the purchase makes up.

C. The size of the expenditure.

D. The time available for adjustments.

E. Luxuries tend to be elastic.

F. Necessities tend to be inelastic.

G. Durable goods tend to be elastic. H. Promotion.

IV. Cross Elasticity of Demand

Shows whether two goods are substitutes or

complements.

Cross Elasticity Percentage Change in Q

Formula Percentage Change in P

If two goods are substitutes, the coefficient will be

positive.

If two goods are complements, the coefficient will be

negative.

V. Income Elasticity of Demand

Shows the responsiveness of certain goods to changes

in real consumer income.

Income Elasticity % Change in Q Demanded

Formula % Change in Real Income

Income-sensitive products have a coefficient higher

than 1.

The coefficient will vary according to income level.

VI. Elasticity of Supply

Shows the responsiveness of quantity supplied to a

change in price.

General Percentage Change in Q Supplied

Formula Percentage Change in Price

Determinants of Supply Elasticity

A. Short-Run Period (inelastic supply)

B. Long-Run Period (more elastic supply)

C. Market Period (short= inelastic; long= elastic)

VII. Applications of Price Elasticity of S and D

A. Wage bargaining (wage give-backs may save jobs if

the product is income-sensitive/ elastic)

B. Bumper crop in agriculture (will reduce the total

revenue of farmers, since products are inelastic.)

C. Automation (if the product is elastic, workers

displaced by automation, may be rehired)

D. Deregulation (works well on elastic goods)

E. Excise taxes, sin taxes (should be applied to

inelastic goods in order to enhance tax revenue)

CHAPTER 21

THE FINANCIAL ENVIRONMENT OF BUSINESS

I. The Legal Organization of Firms

A. Single Proprietorships (over 13 million, 74.3%)

Advantages:

1. Easy to organize

2. The owner is his own boss

3. All profits go to the owner

Disadvantages:

1. Unlimited liability

2. Limited financial resources

3. Owner is responsible for all decisions

B. Partnerships (1.7 million, 7.1%)

Advantages:

1. Easy to organize.

2. Easier to raise capital.

3. More specialization in management.

Disadvantages:

1. Unlimited liability

2. Each partner is responsible for the actions

of all other partners.

3. Division of authority leads to discord

4. The withdrawal of one partner ends the

business.

C. Corporations (over 3 million, 18.6%)

Definition: An artificial person, invisible,

intangible, and existing only in the eyes of the law.

Advantages:

1. Limited liability of stockholders.

2. The ability to raise capital by selling stock.

3. Larger size permits specialization, efficiency

4. Continuity of life ensured.

5. Separation of ownership and control.

Disadvantages:

1. Legally more complex.

2. Principal-agent problem.

3. Double taxation of corporate profits.

II. Methods of Corporate Financing

A. Share of Stock (ownership)

Legal claim to a share of...
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