Key Terms and Concepts

KEY TERMS AND CONCEPTS

Advertising elasticity of demand A measure of the sensitivity of consumer demand for a good or a service in response to a change in the advertising expenditures of a firm or an industry.The advertising elasticity of demand is computed as the percentage change in the demand for a good or a service divided by the percentage change in advertising expenditures.In practice,advertising expenditures are often used as a proxy for tastes and preferences in the demand function. Arc-price elasticity of demand The price elasticity of demand that is calculated over a price–quantity interval by using the simple average as the base.A knowledge of only two price–quantity combinations is required to calculate an arc-price elasticity of demand. Complement In the case of a complement,the change in the demand for a good or service is inversely related to a change in the price of a related good or service,and the cross-price elasticity of demand is negative. Cross-price elasticity of demand A measure of the sensitivity of consumer demand for a good or a service in response to a change in the price of a related good or service.The cross-price elasticity of demand is computed as the percentage change in the demand for a good or a service divided by the percentage change in the price of a related good or service. Elastic demand Demand is elastic when the percentage increase (decrease) in the quantity demanded of a good or a service is greater than the percentage decrease (increase) in its price.When the demand for a good or a service is price elastic,an increase (decrease) in the price of that good or service will result in a decrease (increase) in the total revenue earned by the firm or industry selling that good or service. Elasticity Whenever there is a functional relationship between a dependent variable and an independent (explanatory) variable,it is theoretically possible to calculate a measure of elasticity.Elasticity is a measure of the sensitivity of a dependent variable to changes in an independent (explanatory) variable.Elasticities are computed as the percentage change in the value of the dependent variable divided by the percentage change in the value of the independent (explanatory) variable. Income elasticity of demand A measure of the sensitivity of consumer demand for a good or a service in response to a change in income.The income elasticity of demand is computed as the percentage change in the demand for a good or a service divided by the percentage change in income. Inelastic demand Demand is inelastic when the percentage increase (decrease) in the price of a good or a service is less than the percentage decrease (increase) in its price.When the demand for a good or a service is price inelastic,an increase (decrease) in the price of that good or a

service will result in an increase (decrease) in the total revenue earned by the firm or industry selling that good or service. Inferior good A good or service is inferior when changes in the demand for it are inversely related to changes in income.In the case of an inferior good,the value of the income elasticity of demand is negative. Luxury In the case of a luxury,the percentage increase (decrease) in the demand for a good or service is greater than the percentage increase (decrease) in income,and the value of the income elasticity of demand is greater than unity. Marginal revenue The change in the total revenue earned by a firm in response to a change in output sold.When marginal revenue is positive then total revenue is increasing.When marginal revenue is negative then total revenue is decreasing.If marginal revenue is positive at lower output levels and negative at higher levels,total revenue is maximized when marginal revenue is zero. Necessity In the case of a necessity,the percentage increase (decrease) in the demand for a good or service is less than the percentage increase (decrease) in income,and the value of the income elasticity of demand is positive and less than unity (i.e.,a positive fraction). Normal good or service In the case of a normal good or service,changes in the demand are positively related to changes in income,and the value of the income elasticity of demand is positive.Normal goods and services may be further classified as luxuries and necessities. Point-price elasticity of demand The price elasticity of demand that is calculated at a specific price–quantity combination.A knowledge of the demand equation for a good or a service is required to calculate a pointprice elasticity of demand Price elasticity of demand A measure of the sensitivity of the quantity demanded of a good or a service in response to a change in the price of that good or service.The price elasticity of demand is computed as the percentage increase (decrease) in the quantity demanded of a good or a service divided by the decrease (increase) in the price of that good or service. Price elasticity of supply A measure of the sensitivity of the quantity supplied of a good or a service in response to a change in the price of that good or service.The price elasticity of supply is computed as the percentage increase (decrease) in quantity supplied of a good or service given a percentage increase (decrease) in the price of that good or service. Related good or service Changes in the demand for a good or a service are sometimes related to changes in the price of some other good or service.Related goods and services may be further classified as complements and substitutes.