🛒principles of microeconomics review

key term - Price Elasticity

Definition

Price elasticity is a measure of the responsiveness of the quantity demanded of a good or service to changes in its price. It quantifies the degree to which the demand for a product changes when its price changes.

5 Must Know Facts For Your Next Test

  1. Price elasticity is a key concept in understanding how changes in equilibrium price and quantity occur.
  2. Price elasticity plays a crucial role in determining the effects of price ceilings and price floors on market outcomes.
  3. A profit-maximizing monopoly will choose an output and price combination based on the price elasticity of demand in the market.
  4. Factors that influence price elasticity include the availability of substitutes, the proportion of income spent on the good, and the time horizon considered.
  5. Understanding price elasticity is essential for businesses to make informed pricing decisions and for policymakers to assess the impact of price-related interventions.

Review Questions

  • Explain how price elasticity of demand affects the changes in equilibrium price and quantity.
    • The price elasticity of demand plays a crucial role in determining the changes in equilibrium price and quantity. When demand is elastic, a change in price will lead to a relatively larger change in quantity demanded, resulting in a more significant shift in the equilibrium. Conversely, when demand is inelastic, a change in price will lead to a relatively smaller change in quantity demanded, resulting in a less pronounced shift in the equilibrium. The degree of price elasticity, therefore, shapes the magnitude of the changes in equilibrium price and quantity.
  • Describe how price elasticity of demand influences the effects of price ceilings and price floors.
    • The price elasticity of demand determines the impact of price ceilings and price floors on market outcomes. When demand is elastic, the imposition of a price ceiling or floor will result in a larger change in quantity demanded, leading to more significant shortages or surpluses, respectively. Conversely, when demand is inelastic, the same price interventions will result in smaller changes in quantity demanded, leading to less pronounced shortages or surpluses. Understanding the price elasticity of demand is, therefore, crucial in predicting and analyzing the effects of these price-related policies.
  • Analyze how a profit-maximizing monopoly uses price elasticity of demand to determine its output and price decisions.
    • A profit-maximizing monopoly will choose an output and price combination based on the price elasticity of demand in the market. When demand is elastic, the monopoly can increase its revenue by lowering the price, as the increase in quantity demanded will more than offset the lower price. Conversely, when demand is inelastic, the monopoly can increase its revenue by raising the price, as the decrease in quantity demanded will be relatively smaller. By considering the price elasticity of demand, the monopoly can determine the optimal output and price that will maximize its profits, balancing the trade-off between price and quantity.