AP Micro Ch 18

Inferior goods: income elasticity of demand

*A negative income elasticity coefficient designates an inferior good.* Cabbage, used clothes, and long distance bus tickets are likely candidates. Consumers decrease their purchases of inferior goods as income rise.

elastic demand with TR

*If demand is elastic, a decrease in price will increase TR*. Even though a lesser price is received per unit, enough units additionally are sold to more than make up for lower price. TR for the point higher on the line (higher price) is 2400 dollars. If price declines to lower price on the line the TR is 2500. TR in this case increased bc decline in 50 dollars applies to 2 units, with a consequent revenue loss of $500 (yellow area). Visually gain in Blue area exceeds loss in gold area. Overall result is 100 dollar gain *Visual is reversible: if demand is elastic a price will reduce TR. Revenue gained on higher priced units will be more than offset by the Revenue lost from the lower quantity sol*. Bottom line: Other things equal, *when price and total revenue move in opposite directions, demand is elastic*. *Ed greater than 1 meaning percentage change in Qd is greater than % change in price*

Unit elasticity

*The case separating elastic and inelastic demands occurs where a percentage change in price and the resulting percentage change in quantity demanded are the same* 2 percent drop in price 2 percent increase in Qd so unit elastic be Ed is exactly one. so .02/.02 = 1

Unit elasticity with TR

*an increase or decrease in price eaves TR unchanged*. Loss in revenue from lower price exactly offset by gain in revenue from increase in sales. Conversely, gain in revenue from higher unit price is exactly offset by revenue loss associated w decline in Qd. At P1 there is Q1 demanded, yielding TR X. Higher price of P2 has demand D2 producing same TR. Price increase shown in upper left rectangle, but is exactly offset by revenue showed in bottom right rectangle. *No TR change (true for all prices along curve)* Other things equal, *When price changes and TR remains constant, demand is unit elastic. Ed is 1 meaning percentage change in Qd is same as Percentage change in price*

Price elasticity of supply

*degree of this depends on how easily and quickly producers can shift resources between alternative uses*. Easier and more rapid producers shift resources between alternative uses, greater elasticity of supply. Ex- Christmas trees. Firms response to increase in price of trees depends on its abilities to shift from production of other products to production of trees. Shifting resources takes time, and longer the time the greater the resource shiftability. *We can expect a greater response, and greater elasticity, the longer the firm has to adjust to a price change*. Analyzing impact of time on elasticity, economists distinguish among immediate market period, short run, and long run.

The price elasticity coefficient and formula

*economists measure degree of price elasticity or in elasticity with coefficient Ed, defined as % change in quantity demanded of product X, divided by % change in price of product X* The percent changes in equation are calculated by diving the CHANGE in quantity demanded by the ORIGINAL quantity demanded, and by dividing the CHANGE in price by the ORIGINAL price. This restates the formula as... Change in quantity demanded of X Ed = __________________________________________________ Original quantity demanded of X Change in price of X ÷ _________________________________ Original price of X

elastic demand

*elastic if specific percentage change results in a larger percentage change in quantity demanded. Ed will be greater than 1. * Ex suppose 2 percent decline in price of flowers result in 4 percent increase in quant demanded. SO Ed would be .04/.02 which would be 2

Graph for market period

*farmers vertical supply curve during market period, perfectly inelastic bc no time to respond to change in demand D1 to D2*. Resuling price increase from P0 to Pm determines which buyers get the fixed quantity supplied; elicits no increase in output However not all supply curves have to be perfect inelastic immediately after price change. If product not perishable and P goes up, producers may choose to increase Qs by drawing down inventories of unsold, stored goods. *Cause market curve to attain some positive slope (with price increase, increase in Qs).* For farmer *market period may be full growing season. for producer of good that can be cheaply stored, there may be no market period at all*

normal goods: income elasticity of demand

*for most goods, income coefficient Ei is positive, meaning that more of them are demanded as income rises.* Such goods are superior or normal goods. Value of Ei varies greatly among normal goods. Ex) income elasticity of demand for cars is +3 while income elasticity for most farm products is +0.20

Substitute goods: Cross elasticity of demand

*if cross elasticity is positive, meaning sales of X move in same direction in price of Y, then X and Y are substitute goods*. Increase in Evian price, causes more to buy Dasani, resulting in positive cross elasticity. *Larger cross elasticity coefficient, greater substitutability between two products*

inelastic demand

*if specific percentage change in price produces a smaller percentage change in quantity demanded, demand is inelastic. Ed less than one* suppose a 2 percent decline in price of coffee leads to only 1 percent increase in Qd so its elastic bc .01/.02 is 0.5

luxeries versus necessities

*more a good considered to be a luxury rather than a necessity, the greater the elasticity of demand*. Electricity seen as necessity so price increase won't reduce Qd and is relatively inelastic. An extreme case: person does not decline an operation for surgery bc surgeon fee went up. On other hand, vacations (luxuries) can be forgone. If price rises, no hardships without vacations. What about demand for common product like salt? highly inelastic on three accounts: few substitutes, negligible item in fam budget, and rather necessary

proportion of income

*other things equal, the higher price of relative good to consumers incomes, the greater price elasticity*. 10 percent increase in low price pencil only have a few cent diff and low effect on demand quantity. *Thus price elasticity for low price items tend to be low*. But 10 percent increase in cars has large effect on price and Qd diminish significantly. *price elasticity for high priced items will be high*

Time

*product demanded more elastic the longer the time period under consideration*. Consumers often need time to adjust to prices. Ex- when price rises, time needed to find and try other products to see if they're good. *consumers may not immediately reduce purchases much when price of beef rises, but in time they may shift to to fish.* Another consideration is *product durability*. Studies show short run demand for gas (people stuck w present cars) more inelastic than long run demand (rising gas eventually replacing with smaller fuel efficient cars; may switch to mass transit when available).

Substitutability

*the larger the number of substitute goods that are available, the greater the price elasticity of demand*. Various brands of candy bars generally substitutes making demand for one brand highly elastic. Demand for tooth repair inelastic bc not many substitutes. elasticity of demand for product depends on how narrowly product is defined. Demand for nike more elastic than shoes overall. Many substitutes for reebok, not many for shoes

Total Revenue (TR)

*total amount a seller receives from the sale of product in particular time period; multiply price by quantity sold*. Importance of elasticity for firms relates to effect of price changes on total revenue and thus profits (TR-total cost)

why use percentages rather than absolute amounts in measuring consumer responsiveness? (2 reasons)

1. *If we use absolute changes, the choice of units ill arbitrarily affect our impression of buyer responsiveness*. (Price of popcorn goes down one dollar and 40 more purchases, its seen that there sensitive to price changes and elastic. But if dollar drop changed to pennies, 100 pennies cause change in 40 by amount demanded making it falsely seem elastic). We avoid this by using percentage changes. *This particular price decline is the same whether we measure dollars or pennies* 2. *Using percentages we can correctly compare consumer responsiveness to changes in price of diff products.* Makes little sense to compare effects on quantity demanded of a one dollar increase in car price and one dollar increase in price of one dollar drink. Here, price of used car increased small percent and drink increase 100%. *we can more sensibly compare consumer responsiveness to price increases by using come common percentage increase for price of both*

Price elasticity of demand is greater

1. larger substitutes available 2. higher price of product relative to ones budget 3. greater extent to which product is luxury 4. longer time period involved

Price elasticity along a Linear Demand curve

2 previous demand curves (for elasticity and inelasticity) were movement along straight lines. However elasticity varies over different price ranges on same demand curve (except for unit elasticity where it is 1 along whole curve). For demand curves, more elastic toward upper left (5-8 dollars price range) than toward lower right (4-1 dollars price range). *In upper left of curve, change in quantity demanded is larger bc original preference for quantity is small. Also percentage change in price small here bc original price preference is higher* Relatively large percent change in Qd divided by low change in price yields larger Ed, an elastic demand Reverse holds true for lower right. *% change in Qd is small bc original reference Qd large. Also percent change in price large bc original preference price is small*. Relatively small % change in Qd over large % change in price has small Ed, inelastic demand

The ______ of two prices and two quantities used as the base references in calculating the % changes

AVERAGE

Antiques and reproductions: application of price elasticity of supply

Antiques road show popular TV in which people bring antiques for appraisal by experts. Some people happy to make a lot for something old. *High price of antiques result from strong demand, and limited, highly inelastic supply*. Genuine antique no long produced so supply doesn't change (only slight change in price). Higher price might bring more quantity discoveries, but this quantity usually small. *Supply for these tend to be inelastic. One of a kind antiques are perfectly elastic* Factors like pop increase, higher income, and greater happiness for collecting antiques increase demand for antique over time. *Bc Supply limited and inelastic, those increases in demand greatly increase price of antiques*. Contrast inelastic supply of original antiques w new made to look old knickknacks. *When demand for reproduction increases, firms making them simply boost production (supply highly elastic, so increase demand only raises price slightly)*

Insights

Coefficients of income elasticity of demand provide insights into the economy. Ex- income elasticity helps explain expansion and contraction of industries. Total income on average grown 2-3% annually. *As income expanded, industries producing products for which demand is quite income elastic have expanded their outputs.* Cars, housing, and books experienced growth in output. *Industries producing products for which income elasticity is low or negative have tended to decline or grow slower*. Ex- agriculture grown slower than economy's total output. *We do not eat twice as much when incomes double* *when recessions occur and people's income decline, grocery stores fare relatively better than stores selling electronic equipment*. people do not cut back on purchases when incomes fall, *income elasticity for food is low*. But they do cut back on purchases of electronic equipment; *income elasticity on such equipment is relatively high*.

relatively elastic vs inelastic

For some products like restaurant meals, consumers have high responses to price changes. *Modest price changes cause large changed in quantity purchased. the demand for such products are relatively elastic or just elastic* for products like toothpaste, consumers pay much less attention to price cahnges. *substantial price changes only cause small changes in amount purchased. The demand for these are relatively inelastic or inelastic*

Total revenue (TR) test

Graphically TR represented by P x Q rectangle lying below a point on a demand curve. So if price is 2 and Qd is 10, TR is 20 bucks shown by rectangle under demand curve. Area of rectangle finds TR TR and price elasticity of demand are related and the *easiest way to infer where demand is elastic or inelastic to to employ TR test. * Note what happens to TR when price changes. *If TR changes in opposite direction of price, demand is elastic. If TR changes in same direction of price, demand is inelastic. If TR does not change when price changes, demand is unit elastic*

Inelastic demand with TR

If demand inelastic, price decrease reduce TR. Increase in sales won't offset decline in revenue per unit and TR will decline. If at one point Price is 20 and quantity demanded is 16, TR is 320. If price drops to 10 dollar and Qd moves to 20, TR moved down to 200, which TR is less than 320. *TR declined bc loss of revenue (upper left rectangle) from lower unit price is larger than gained revenue (rectangle in corner of graph) from the accompanying increase in sales. Price has fallen, TR also decline* Reversible: *if demand is elastic, price increase will increase total revenue*. So all things equal, *when price and TR move in same direction, price is inelastic*. *Ed is less than one meaning % change in Qd is less than percent change in price*

other things equal, competitive markets produce equilibrium prices and quantities that ________ sum of consumer and producer surplus

MAXIMIZE

allocative efficiency occurs at quantity levels where three conditions exists

MB=MC Max willingness to pay = minimum acceptable price combined consumer and producer surplus is at max

Volatile gold prices: application of price elasticity of supply

Price of gold volatile, sometimes shooting up and plummeting in P. *main sources of these fluctuation are shifts in demand and highly inelastic supply*. Gold production time and cost consuming. Physical availability limited. *increase in gold price do not elicit big increase in Qs.* Conversely, gold mining costly to shut down and existing gold bars expensive. *Price decreases therefore do not produce large drops in Qs of gold, so inelastic* demand for gold derived from demand for its uses (coins, jewelry, etc). Also for financial investments. *Increase in demand for gold when fear general inflation that might undermine currency. Reduce demand when events settle down*. Bc inelastic supply of gold, even *small changes in demand, produce big price changes*.

Many economists predict legalization of hard drugs would ________ street prices up to __________

REDUCE street prices up to 60%, depending on if and how much they were taxed. Study said price declines of that size increase users of heroin 54% and cocaine 33%. Total quantity of Heroin demanded rise estimated 100% and cocaine demand 50%. *moreover, many existing and first time dabblers might in time become addicts. The Overall results, say opponents of legalization, would be higher social costs, possibly including an increase in street crime*

efficiency losses (deadweight losses): underallocation

Suppose output is Q rather than efficient equilibrium level. the sum of consumer and producer surplus previously from ABC (y inc demand, to equilibrium, to y inc of supply), falls to ADEC (which is from y inc of demand, to point d which is where deadweight loss starts on demand curve, straight down to point e which is where deadweight loss starts on supply curve, and then back to y intc of suppy curve). So it goes from including the whole left side of E point (A, B, C, D, F, E), to including everything but the deadweight loss C and E (A,B, D, F) *So combined producer surplus declines by amount of the yellowish brown triangle. This triangle represents efficiency loss with underproduction*. For the new output levels with the underproduction, max willingness to pay exceeds minimum acceptable price (supply curve). *By failing to produce a product for which a consumer is willing to pay (say 10 dollars), for which producer is willing to accept 6 dollars, society suffers loss of net benefits of 4 dollars. Brown triangle shows total loss of net benefits w underproduction*

Price elasticity of supply: short run

a period of time too short to change plant capacity but long enough to use fixed plant more or less intensively. *the farmer's plant (land and machinery) is fixed. But he does have time in short run to cultivate tomatoes more intensively by applying more labor and adding more fertilizers.* Result is a somewhat *greater output in response to presumed increase in demand*; greater output is reflected in a *more elastic* supply of tomatoes.

Using averages

an annoying problem arises in computing price elasticity coefficient. A price change say from 4-5 bucks along demand curve is 25% increase (=$1/$4), but the opposite price change from $5 to $4 on same curve is 20 percent decrease ($1/$5). Which of these percents do we use in denominator to compute? And when quantity changes for example 10 - 20 (10/10) is 100% increase along demand curve but falling 20 - 10 is a 50% decrease (10/20). Should we use 100 or 50 percent in numerator to compute? *ELASTICITY SHOULD BE THE SAME WHETHER PRICE RISES OR FALLS* Simplest solution is using midpoint formula for calculating elasticity.

consumer surplus example

assume equilibrium price is 8$ per bag. *Portion of demand curve lying above $8 equilibrium price shows that many consumers willing to pay more than $8 per bag rather than go without oranges.* If willing to pay max 13 bucks, and you actually pay 8 at equilibrium, there is a 5 dollar consumers surplus (13-8). If only willing to pay at equilibrium price, no consumer surplus (8-8=0). Reasonable to assume that many people in a market are willing to pay more than $8 per bag. *By adding together individual consumer surpluses obtained by named and unnamed buyers, we obtain collective consumer surplus in this specific market*. To obtain the quantity demanded at equilibrium bags of oranges, consumers collectively willing to pay total amount total amount shown by green triangle and the rectangle under demand curve to the left of the Equilibrium Qd (simply the square in the bottom left corner). Consumers only need to pay amount represented by that corner rectangle, so green triangle is consumer surplus

Efficiency revisted

bringing together demand and supply curves to show both surpluses. All markets that have down sloping demand and up supply supply have the surpluses. Equilibrium quantity reflects economic efficiency. PRODUCTIVE EFFICIENCY achieved bc competition forces producers to use combos of resources in growing and selling oranges. Production cost of each level of output minimized. ALLOCATIVE EFFICIENCY is achieved bc correct quantity of output is produced relative to other g/s. Points on demand curve measure marginal benefit (MB) of oranges at each level of output. Points on the supply curve measure marginal cost (MC) of oranges at each output level bc it shows the cost added by producing one additional unit of a product or service.. Intersect at equilibrium output MC=MB Our analysis of consumer and producer surplus provides another way of thinking about efficiency. *Each point on demand curve identifies not only MB of corresponding unit of output, but also MAX WILLINGNESS to pay for it*. Willingness to pay derives from benefit product provides. *Each point on supply curve not only identifies marginal cost a good but also MINIMUM ACCEPTABLE PRICE for the good. To stay profitable, sellers much receive minimum prices to cover marginal costs*

Price elasticity of supply Equasion

concept of price elasticity also applies to supply. If *PRODUCERS* are relatively responsive to price changes, supply is elastic and vice versa. Measure w coefficient Es defined like Ed except % change in Qs is substituted for % change in Qd *Averages or midpoints of the before and after quantities supplied and the before and after prices are used as reference points for percent changes*, (same as Ed). Increase 4-6 dollars increases Qs 10-14 units. % change in P (6-4/5)=2/5 (0.4) and % change in Qs (14-10/12)=4/12 (0.33). So Es = 0.33/0.4= 0.83 - elastic bc coefficient less than 1. (>1 = elastic) *Es never negative since price and Qs are directly related. No minus sign to drop as was necessary with price elasticity of demand*

cross and income elasticities of demand

cross elasticity: -Positive *(Ewz>0)* - quantity demanded of W changes in same direction as change in price of Z. Type of goods: Substitutes -Negative *(Exy<0)* - quantity demanded of X changes in opposite direction from change in price Y. Type of goods: complements income elasticity: -Positive *(Ei>0)* - quantity demanded of the product changes in same direction as change in income. Type of goods: normal, superior -Negative *(Ei<0)* quantity demanded of product changes in opposite direction from change in income. Type of goods: Inferior

relationship between price elasticity of demand and total revenue

demand curve shows hypothetical weekly demand for DVD is elastic at higher price ranges and inelastic at lower. The TR curve is derived from demand curve. When price falls, Qd increases, and TR increases, demand is elastic. When price falls and TR is unchanged, demand unit elastic; when price falls and TR declines, demand inelastic

Large crop yields: application of price elasticity of demand

demand for most farm products inelastic; increasing output of farmer products arising from a good growing season or from increased productivity tend to depress both price of farm products and TR. For farmers as group, *in elasticity means large crop yields may be undesirable. For policy makers it means achieving goal of higher total farm income requires farm output be restricted*

there is a ______ relationship between equilibrium price and amount of producer surplus

direct/positive lower prices reduce producer surplus, and higher price increases it. If you draw lower Ep you see producer surplus triangle is smaller and vice versa *Gap between minimum acceptable payments and actual prices narrow when price falls. Gaps between minimum acceptable payments and actual price widens when price increases.*

Excise taxes: application of price elasticity of demand

govt pays attention to Ed when it selects g/s on which to levy excise tax. If a 1 dollar tax is levied on product and 10,000 units sold, tax revenue is $10,000 (1 x 10,000). If govt raises tax to $1.50 the higher price that results reduces sales to 4000 bc of elastic demand, tax revenue decline to $6000 (1.5 x 4000). *Bc higher tax on product with elastic demand will bring less tax revenue, legislatures tend to seek out products having inelastic demand when levying.* In fact, federal govt, in effort to reduce budget deficit, increased taxes on alcohol, gas, cigs, etc (inelastic goods)

Demand typically more elastic in ....

high price, low quantity range of demand curve (upper left) and inelastic in low price, high quantity range. (lower right)

Complementary goods: cross elasticity of demand

if cross elasticity is negative, we know X and Y go together. *Increase in price of one, decreases demand for the other*. Increase in digital cam price will decrease amount of memory sticks purchased. *Larger the negative coefficient, greater compliments the products are*.

When price changes, TR will change in the opposite direction if... in same direction if.... and not at all if...

if demand is price elastic demand is price inelastic demand is unit elastic

Graph for short period

increase in demand from D1 to D2 is met by increase in quantity (Q0 to Qs) so there is a smaller price adjustment (P0 to Ps) than would be the case in the market period. *Equilibrium price therefore lower in short run than in market period* plant capacity is fixed, but changing the intensity of its use can alter output; therefore supply is more elastic, and it not perfectly vertical (inelastic) anymore

Interpretations of Ed

interpret coefficient of price elasticity of demand as follows elsatic, inelastic, unit, and extreme cases

consumer surplus and price are ______ related

inversely/negatively Given demand curve, higher prices reduce consumer surplus and lower increase it. To test draw Ep above 8 and observe reduction in size of consumer surplus triangle. *when price rises, the gap narrows between max willingness to pay and the actual price.* Drawing an Ep line below 8 dollars shows increase in consumer surplus triangle. *When price falls, gap widens between max willingness to pay and actual price*.

efficiency example

max willingness to pay (on demand curve) for each bag of oranges (Q) up to Eq exceeds corresponding minimum acceptable price (on supply curve) - so demand above supply curve. *So each of these bags (Q) add a positive amount (= max willingness to pay - minimum acceptable price) to total of consumer and producer surplus.* Only at Eprice where max willingness to pay equals minimum acceptable price for that unit, does society exhaust all the opportunities to add to combined consumer and producer surpluses. *so allocative efficiency occurs where triangle representing "consumer surplus + producer surplus" is at its max size (which is when MB=MC)*

Cross elasticity of demand

measures how sensitive consumer purchases of one product (A) are to a change in the price of some other product (B). Calculate coefficient of cross elasticity of demand *Exy* just as we do of simple price elasticity, except we relate % change in consumption of A/X to % change in B/Y *This cross elasticity or cross price elasticity concept allows us to quantify and more fully understand substitute and complementary goods*

Income elasticity of demand

measures the degree to which consumers respond to a change in their incomes by buying more or less of a particular good. Coefficient of income is Ei.

Price elasticity and the total revenue curve

on TR curve, *TR was graphed per week corresponding to each price quantity combo indicated along the demand curve (linear)*. Price - quantity - demanded combo represented by point a on demand line (point lining up with 7 dollars and 2 demanded) yields TR 14 bucks. This was graphed vertically at 2 units demanded. Similarly, combo at point b on demand line (4 bucks 6 demanded) has TR of 24, graphed vertically at 4 units demanded on TR curve. Final result is TR curve which first slopes up, reaches max, and turns down. Comparison of these two curves focuses relationship between Elasticity and TR. *lowering ticket price in elastic range increases TR. Increasing ticket price in that range reduces TR. In both cases, P and TR change in opposite directions, confirming elastic.* 4 dollar range shows unit at a single point. But if the y intc of demand line was an odd number like 9 (shift demand line right one unit), unit elasticity would be from 4-5 dollar range (not one set point), meaning going up from 4-5 or down 5-4 would have same TR. *Price would change (between 4-5) and TR constant* Inelastic range, lowering price decrease TR and vice versa. *Price and TR move in same direction so inelastic*

overproduction causes efficiency losses bc

output is being produced for which minimum acceptable prices is higher than max willingness to pay

Underproduction causes efficiency losses bc

output is not being produced for which max willingness to pay exceeds minimum acceptable price

extreme cases

perfectly elastic and perfectly inelastic

Cross elasticity and income elasticity of demand

price elasticities measure responsiveness of quantity of product demanded or supplied when its price changes. Consumption of a good also affect by change in price of related product or by change in income.

efficiency loss with overproduction

produce at q3 rather than q1 now. Combined consumer and producer surplus declines by bfg (green triangle to right of Q1). This triangle subtracts from total consumer and producer surplus of abc that would occur if quantity be at Q1. *For all units beyond Q1, consumers max willingness to pay (demand curve) is less than producer minimum acceptable price*. Producing item at willingness of $7 which accepted price is 10, society loses 3 dollars from net benefit. *Triangle bfg shows total efficiency loss from overproduction at Q3.* Under most conditions however competition ensures right amount of good gets made.

producer surplus

producers also receive benefit surplus in market. Its the diff between the actual price a producer receives and the minimum acceptable price. *sellers collectively receive a producer surplus in most markets bc most sellers willing to accept a lower than E price if that is required to sell*. That lower acceptable price is shown by portion of supply curve lying to left and below assumed $8 Equilibrium price (orange triangle) Someones minimum acceptable payment for bag of oranges is 3 bucks, and its price at Ep is 8 so there is 5 dollar producer surplus. someone else's minimum acceptable price is 8, and at Ep of 8, there is 0 surplus. Each seller receives as payment the Ep of 8 dollars. *summing producers surplus of sellers we obtain producer surplus for entire market*. The Ep x Eq is what the producers collect as revenue. however revenues of only those illustrated by the triangle next to the red one would be required to entice producers to offer Q1 (Eq) bags of oranges for sale. *sellers therefore get surplus shown by red triangle; surplus is sum of vertical distances between the supply curve and the 8 dollar Ep at each quantities left of Eq*

Decriminalization of illegal drugs: application of price elasticity of demand

recently proposals to legalize drugs widely debated. some say they should be treated like alcohol, and made legal for adults for purity and potency. Argued current war on drugs has been unsuccessful and associated costs (like more prison and police) has increased markedly. *Legalization would allegedly reduce drug trafficking by taking profit out of it*. Crack cheap to produce and sold low price in legal markets. *Addicts inelastic, so amount consumed at lower price only increase modestly*. Total addict spending for drugs would decline, and so would street crime that finances those spendings. Opponents say overall demand more elastic than supporters say. *In addition to elastic addicts, there are still 'dabblers' who use hard drugs at low prices or substitute alcohol when drug P higher*. Thus, *lower prices w legalization of hard drugs would increase dabbler use*. Removal of restrictions against using drugs may make it *more socially acceptable* increasing demand for hard drugs.

efficiency losses

reductions of combined consumer and producer surplus -- associated with under or overproduction of a product.

perfectly elastic

saying elastic doesnt mean consumers are completely responsive to price changed. *In extreme cases where small price deduction causes buyers to increase purchases from zero to all they can obtain, the elasticity coefficient is INFINITE and economists say its perfectly elastic* *a line parallel to horizontal axis shows this. Such demand applies to a firm that is selling its products in a purely competitive market* Ed= infinity

Price elasticity along a linear demand curve: slope

slope of demand curve pictured is not a sound basis for judging elasticity. *catch is that Slope of curve computed from absolute changes in price and quantity, while elasticity involves relative or percent changes in price and quantity. * Demand curve pictured is linear, meaning slope is constant. But we know such a curve is elastic in high price range and inelastic in low price range.

Elasticity cannot be judged by...

steepness or flatness of a demand curve

Consumer surplus is the....

sum of the vertical distances between the demand curve and the $8 equilibrium price at each quantity up to Equilibrium quantity. Alternatively, it is the sum of the gaps between max willingness to pay and actual price *difference between what They are willing and able to pay at the demand curve, and below up until what they do pay, which is the market/Equilibrium price*

Consumer surplus

the benefit surplus received by a consumer or consumers in a market. Difference between the max price a consumer is willing to pay for a product and the actual price. *In nearly all market, consumers individually and collectively gain greater total utility in dollar terms (total satisfaction) from their purchases than the amount of their expenditures (=product price x quantity)*. This utility surplus arises bc all consumers pay Equilibrium price even through many would be willing to pay more than that to obtain product

Application: cross elasticity of demand

the degree of substitutability of products, measured by cross coefficient, is important to business and govt. Suppose coke considering whether or not to change price of sprite brand. Want to know sprites price elasticity, but it will also be interested in knowing if increased sales of Sprite will come as expense to coke brand. How sensitive are sales of one coke products to change price of another of its products sprite. *low cross elasticity indicate sprite and coke weak substitutes so lower price on sprite limited effect on coke sales.* govt uses cross elasticity idea in assessing whether merger of firms will reduce competition and violate antitrust laws. Cross elasticity between coke and pepsi high, making strong substitutes. *govt would block merger bc it would lessen competition*. *In contrast, cross elasticity is 0 between gas and coke so a merger would have minimal effect on competition.* govt would let merger happen

Price elasticity of demand

the law of demand says consumers will by more when price decreases and vice versa. But how much more or less would they buy? The amount varies from product to product over different price ranges for the same product. It also may vary over time. EX) firms contemplating price hike (increase) would want to know how consumers will respond. If they stay loyal and keep buying, firms revenue rises. But if they defect to other sellers or products, its revenue would tumble. *the responsiveness (or sensitivity) of consumers to a price change is measured by a products price elasticity of demand*.

For quantity Q1 (equilibrium quantity), producers receive the sum of the amount represented by...

the orange and tan triangle (in the rectangle forming from Ep and Eq, the orange triangle is the left of the supply curve and tan to the right). Because they receive only the amount shown by the tan triangle, the orange triangle to the left of the supply curve reflects producer surplus. The red triangle represents producer surplus. Producer surplus exists when the price goods are sold for is greater than what it costs the firms to manufacture those goods. Producer surplus is defined by the area above the supply curve, below the price, and left of the quantity sold. *it is the diff between price the producers are willing and able to supply (below equilibrium/market price) at what they actually receive at the market price*

Price elasticity of supply: Market period

the period that occurs when the time immediately after a change in market price is too short for producers to respond with a change in quantity supplied. Suppose owner of farm bring on truck of tomatoes that is entire seasons output. *Supply curve for tomatoes perfectly inelastic (vertical); the farmer will sell truckload with P high or low, bc farmers can offer one truckload, even if more was anticipated*. He or she might like to offer more, but more can't be made that fast. Need another full season. Perishable goods, so can't be withheld from market. *If price is lower than expected, he will still sell entire truckload*. So farmer cost to produce not enter in decision to sell. Though price may fall short of costs, still need to sell all to avoid total loss w spoilage. *During market period, famers supply of tomatoes is fixed: only one truckload offered no matter the price*

Midpoint for calculating elasticity

this formula simply *averages the two quantities as the reference points for computing the percentages. * For the same 5 - 4 dollar price range, the price reference is $4.5 {= ($5 = $4)/2} and for the same 10-20 quantity range the quntity reference is 15 units {= (10+20)/2}. The percentage change in price is now $1/$4.50 or about 22 percent and the percent change in quantity is 10/15, or about 67 percent. *So Ed is about 3 in this case*. This solution eliminated the up vs down problem. *All the price elasticity coefficients that follow are calculated using this midpoint formula. *

Price elasticity of supply: the long run

time period long enough for firms to adjust their plant sizes and for new firms to enter (or existing firms to leave) the industry. In tomatoes, *farmer has time to acquire additional land and buy more machinery and equipment. other Farmer may over time be attracted to tomato farming by increased demand and higher price*. Such adjustments create *large supply response, making a more elastic (horizontal) curve.* Smaller price rise (P1-P4) and larger output increase (Q1 to Q4) in response in increase of demand *No TR test for elasticity of supply*. Supply shows direct relationship between price and amount supplied; *unsloping supply curve*. Regardless of degree of elasticity or inelasticity, price and TR always move together

Determinants of price elasticity of demand

we cannot say what will determine price elasticity of demand at each situation, but following generalizations helpful substitutability, proportion of income, luxuries vs necessities, time

Elimination of minus sign

we know from down slope of demand curve price and quantity inverse. Thus price elasticity of demand Ed will always be negative (ex if price declines, quantity demanded increase meaning numerator in our formula (demand) would be positive and denominator negative making negative Ed. Same w if price increase and demanded decrease making the numerator negative). economists ignore minus sigh and present absolute val of elasticity coefficient to avoid ambiguity. Confusing to say Ed of -4 is greater than one of -2. *So in what follows, ignore minus sign in coefficient of price elasticity of demand and show absolute val*. The ambiguity does not arise w supply bc price and quantity both positively related. *All elasticity of supply coefficients therefore positive*

perfectly inelastic

when we say demand is inelastic we don't mean consumers are completely unresponsive to price change. *In extreme case where a price change results in no change whatsoever in Qd its perfectly elastic*. Price elasticity coefficient is 0 bc no response to change in price. Approximate examples are acute diabetic demand for insulin and heroin for addicts. *line is parallel to vertical axis* Ed = 0

Independent goods: cross elasticity of demand

zero or near zero cross elasticity suggests two products are unrelated. Walnuts and plums: not expect change in price of walnuts to have any effect on plums and vice versa