Behind the Demand Curve: Consumer Choice — Hard Practice Quiz
A Microeconomics cheat sheet for Behind the Demand Curve: Consumer Choice — every key formula with its symbols defined — plus a hard-level practice quiz to test recall.
Formulas & key concepts
When a good's price rises, consumers shift some of their purchases toward now-relatively-cheaper substitutes; this substitution away from the pricier good is one reason the demand curve slopes downward.
A price change alters a consumer's real purchasing power; a higher price effectively makes the consumer poorer, reducing the quantity bought and reinforcing the law of demand.
A measure of how strongly quantity demanded responds to a price change, found by dividing the percent change in quantity demanded by the percent change in price (ignoring the minus sign).
A technique for computing elasticity that uses the average of the starting and ending values as the base for each percent change, so the result is identical whether the price rises or falls.
Quantity demanded does not change at all when price changes, giving an elasticity of zero and a vertical demand curve.
Buyers will purchase any amount at one particular price but nothing above it, giving an infinite elasticity and a horizontal demand curve.
A price elasticity greater than 1, meaning quantity demanded changes more than proportionally to a price change.
A price elasticity less than 1, meaning quantity demanded changes less than proportionally to a price change.
A price elasticity exactly equal to 1, so the percent change in quantity demanded matches the percent change in price.
The total value of sales, equal to the price multiplied by the quantity sold.
A price increase raises revenue earned per unit (price effect) but reduces units sold (quantity effect); which force dominates determines whether total revenue rises or falls.
If demand is elastic, raising price lowers total revenue; if demand is inelastic, raising price increases total revenue; if unit-elastic, total revenue is unchanged.
Along a straight-line demand curve, demand is elastic at high prices and inelastic at low prices, so a good's elasticity is measured at a specific point.
Demand is more elastic when close substitutes exist, when the good is a luxury rather than a necessity, when it absorbs a large share of income, and when more time has passed since the price change.
The percent change in demand for one good divided by the percent change in another good's price; it is positive for substitutes and negative for complements.
The percent change in quantity demanded divided by the percent change in income; it is positive for normal goods and negative for inferior goods.
An income elasticity greater than 1, where demand for the good grows faster than income, as is typical of luxuries.
A positive income elasticity below 1, where demand rises with income but more slowly, as is typical of necessities.
The percent change in quantity supplied divided by the percent change in price, measuring how responsive producers are to price changes.
Quantity supplied stays fixed no matter the price, giving a vertical supply curve.
Producers will supply any quantity at a particular price but none below it, giving a horizontal supply curve.
Supply is more elastic when additional inputs can be obtained cheaply and easily and when more time has passed since the price change.
The highest price a consumer is prepared to pay for a good; it sets the height of the demand curve.
The net benefit a single buyer gains from a purchase, equal to willingness to pay minus the price actually paid.
The combined surplus of all buyers in a market, shown graphically as the area beneath the demand curve and above the market price.
The lowest price a producer will accept to supply a unit, reflecting the value of the resources used to make it.
The net gain a single seller earns, equal to the price received minus the seller's cost.
The combined surplus of all sellers, shown as the area above the supply curve and below the market price.
The overall gain to society from a market, equal to consumer surplus plus producer surplus.
A higher market price transfers surplus from consumers to producers, while a lower price shifts surplus from producers to consumers.
A competitive market usually maximizes total surplus, so no reshuffling of who consumes or produces can make anyone better off without making someone else worse off.
Markets tend toward efficiency, but because society also values fairness, a policy that lowers efficiency can still be worthwhile if it improves equity.
A tax on the sale or purchase of a particular good that raises the price buyers pay and lowers the price sellers keep.
The gap an excise tax drives between the price consumers pay and the price producers receive, equal to the amount of the tax.
How the burden of a tax is divided between buyers and sellers; it does not depend on which party legally sends the tax to the government.
The heavier tax burden falls on whichever side of the market is less elastic; if demand is less elastic than supply, consumers bear most of the tax.
The loss of total surplus when a tax or other distortion discourages mutually beneficial transactions, shown as a triangle that grows larger the more elastic supply or demand is.
The money a tax raises, equal to the tax per unit times the number of units still bought and sold.
The resources used to collect, comply with, and evade a tax, over and above the tax payment itself.
A tax that takes a larger fraction of income as income rises.
A tax that takes a smaller fraction of income as income rises.
A tax that takes the same fraction of income at every income level.
A fixed tax owed equally by everyone regardless of their behavior; because it does not distort choices, it creates no deadweight loss.
A measure of the satisfaction a consumer receives from consuming goods and services.
The hypothetical unit economists use to quantify a consumer's utility.
The overall satisfaction a consumer gains from an entire consumption bundle.
The additional utility obtained from consuming one more unit of a good or service.
A graph of how marginal utility changes as more of a good is consumed; it generally slopes downward.
Each successive unit of a good consumed adds less extra satisfaction than the unit before it.
The requirement that a consumer's total spending cannot exceed his or her income.
The full set of consumption bundles a consumer can afford given current income and prices.
The boundary of the budget constraint, showing every bundle a consumer can buy when spending all available income.
The affordable combination of goods that gives the consumer the greatest possible total utility.
The marginal utility of a good divided by its price, showing the extra satisfaction gained from the last dollar spent on it.
Total utility is maximized when the marginal utility per dollar is the same for every good the consumer buys.
Because buyers barely change how much they want when the price moves, the price of flu vaccine is driven mainly by how much supply is available.
As household income rises, the share of income spent on food falls, reflecting the low income elasticity of demand for food.
A rare exception to the law of demand in which a price rise increases quantity demanded, because for a staple good a strong income effect outweighs the substitution effect.
Since selling kidneys for transplant is illegal, organs are rationed through a waiting-list system run by UNOS rather than by price, a real case of non-price allocation and surplus.
Practice quiz
A firm observes that when it increases the price of its product by $10\%$, the quantity demanded falls by $5\%$. If the firm's goal is to maximize total revenue, what action should it take, and why?
- Decrease the price, because demand is inelastic, meaning the quantity effect is smaller than the price effect.
- Increase the price, because demand is inelastic, meaning the quantity effect is smaller than the price effect.
- Decrease the price, because demand is elastic, meaning the quantity effect is larger than the price effect.
- Increase the price, because demand is elastic, meaning the quantity effect is larger than the price effect.
Answer: Increase the price, because demand is inelastic, meaning the quantity effect is smaller than the price effect.
The government imposes an excise tax on a good. Initially, the price elasticity of demand is $0.8$ and the price elasticity of supply is $1.2$. If, over time, consumers find more substitutes, making the demand elasticity $1.5$ while supply elasticity remains $1.2$, what will be the likely impact on tax incidence and deadweight loss?
- The tax burden will shift more towards consumers, and deadweight loss will decrease.
- The tax burden will shift more towards producers, and deadweight loss will decrease.
- The tax burden will shift more towards consumers, and deadweight loss will increase.
- The tax burden will shift more towards producers, and deadweight loss will increase.
Answer: The tax burden will shift more towards producers, and deadweight loss will increase.
A consumer is currently maximizing utility by consuming goods $X$ and $Y$ such that $\frac{MU_X}{P_X} = \frac{MU_Y}{P_Y}$. If the price of good $X$, $P_X$, suddenly decreases, while $P_Y$ and the consumer's income remain constant, what is the immediate effect on the marginal utility per dollar for good $X$, and what action will the consumer take to restore equilibrium?
- $\frac{MU_X}{P_X}$ will decrease, leading the consumer to buy less of $X$ and more of $Y$.
- $\frac{MU_X}{P_X}$ will increase, leading the consumer to buy more of $X$ and less of $Y$.
- $\frac{MU_X}{P_X}$ will decrease, leading the consumer to buy more of $X$ and less of $Y$.
- $\frac{MU_X}{P_X}$ will increase, leading the consumer to buy less of $X$ and more of $Y$.
Answer: $\frac{MU_X}{P_X}$ will increase, leading the consumer to buy more of $X$ and less of $Y$.
A household's income increases by $20\%$. As a result, their consumption of good A increases by $15\%$, and their consumption of good B decreases by $10\%$. Which of the following statements is true regarding these goods?
- Good A is an income-elastic normal good, and Good B is an inferior good.
- Good A is an income-inelastic normal good, and Good B is an inferior good.
- Good A is an income-elastic normal good, and Good B is a normal good.
- Good A is an income-inelastic inferior good, and Good B is a normal good.
Answer: Good A is an income-inelastic normal good, and Good B is an inferior good.
For a particular good, when its price increases, the substitution effect leads to a decrease in quantity demanded. However, the income effect, which is substantial and positive, causes an increase in quantity demanded that outweighs the substitution effect. What type of good is this, and what does this imply about its demand curve?
- This is a normal good with an upward-sloping demand curve.
- This is an inferior good with an upward-sloping demand curve.
- This is a normal good with a downward-sloping demand curve.
- This is an inferior good with a downward-sloping demand curve.
Answer: This is an inferior good with an upward-sloping demand curve.
In a competitive market, the equilibrium price is $P^*$ and the equilibrium quantity is $Q^*$. The government imposes a binding price floor at $P_F > P^*$. Assuming the quantity traded is determined by the demand curve at $P_F$ (i.e., $Q_D$ at $P_F$), which of the following is true regarding the changes in consumer surplus (CS), producer surplus (PS), and total surplus (TS)?
- CS decreases, PS increases, TS increases.
- CS decreases, PS increases, TS decreases.
- CS decreases, PS can increase or decrease, TS decreases.
- CS increases, PS decreases, TS decreases.
Answer: CS decreases, PS can increase or decrease, TS decreases.
Consider a rare antique painting. In the short run, its supply is perfectly inelastic. However, for a newly discovered artist whose works can be replicated by skilled forgers over time, the supply of "authentic" pieces might become more elastic in the long run due to improved forgery techniques. If demand for both types of art suddenly increases by the same amount, how would the initial price change for the antique painting compare to the long-run price change for the newly discovered artist's work?
- The antique painting's price would increase less in the short run, and the artist's work price would increase more in the long run.
- The antique painting's price would increase more in the short run, and the artist's work price would increase less in the long run.
- Both prices would increase by the same amount in the short run, but the artist's work price would decrease in the long run.
- The antique painting's price would increase less in the short run, and the artist's work price would decrease in the long run.
Answer: The antique painting's price would increase more in the short run, and the artist's work price would increase less in the long run.
The cross-price elasticity of demand between good A and good B is $0.7$. The price elasticity of demand for good A is $1.3$. If the price of good B increases by $10\%$, and simultaneously the producer of good A decides to increase its own price by $5\%$, what is the combined effect on the quantity demanded for good A and the total revenue for good A?
- Quantity demanded for A will decrease, and total revenue for A will increase.
- Quantity demanded for A will increase, and total revenue for A will decrease.
- Quantity demanded for A will decrease, and total revenue for A will decrease.
- Quantity demanded for A will increase, and total revenue for A will increase.
Answer: Quantity demanded for A will increase, and total revenue for A will decrease.
The price of a popular smartphone decreases from $800$ to $600$. As a result, the quantity demanded increases from $10,000$ units to $15,000$ units. Using the midpoint method, calculate the price elasticity of demand and classify the demand.
- $1.4$, elastic demand.
- $0.71$, inelastic demand.
- $1.0$, unit-elastic demand.
- $0.8$, inelastic demand.
Answer: $1.4$, elastic demand.
A government is considering two tax policies to raise a specific amount of revenue: an excise tax on a good with elastic demand and supply, or a lump-sum tax on all citizens. From the perspective of market efficiency, which tax is preferable, and why?
- The excise tax, because it targets specific goods and can be adjusted to minimize consumer burden.
- The lump-sum tax, because it does not distort choices and therefore creates no deadweight loss.
- The excise tax, because it generates more tax revenue for the same level of deadweight loss.
- The lump-sum tax, because it is generally more progressive and improves equity.
Answer: The lump-sum tax, because it does not distort choices and therefore creates no deadweight loss.
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