econ test 2 ch. 4, 5, 6, 7
Normative analysis
assesses what should happen Prescribes what should happen, which involves value judgments Which is the better outcome and what policy should the government adopt? Makes judgment
ex:
cutting price of gas by 20% leads to increase in quantity demanded of about 10% → price of gas=-.5 elasticity (10/-20)
floor of NY stock exchange
financial market, prices change second by second as millions won and lost, as traders buy and sell stock in companies
elastic demand curves are relatively
flatter than inelastic demand curves
Cross-price elasticity is near zero
for independent goods Aka shoes and pepsi Unrelated goods=cross-price elasticity of near zero
Tax on Buyers
shifts the demand curve Tax on buyers causes decrease in demand (interdependence principle in action→ choice of gov affects your decision)
Binding price ceiling can lead to
shortages and queuing
Whenever price is rising,
sign that at the current price, the quantity demanded exceeds the quantity supplied
The factor that is more elastic will have a
smaller share of the economic burden
Should search harder for
storable goods than perishable ones Demand for storable goods more elastic than for perishable goods cuz substitutability-today's low price on detergent is a substitute not just for buying it a higher price today, but also for buying detergent next month
And SO the more elastic a seller's supply curve is,
the smaller their share of the economic burden
A tax on sellers shifts
the supply curve
When the price of elasticity of demand is large relative to the price elasticity of supply
then buyers bear a smaller share of the economic burden
if price of elasticity of supply is larger
then the share of the economic burden paid by sellers is smaller In this case, the money is coming from buyers who pay higher prices rather than giving up a lot of consumption End result is that whichever factor is more elastic bears less of the economic burden of the tax Underlying logic is that you "get out of the way" of taxes by changing quantities you buy or sell When comes to soda buyers demand relatively more inelastic than sellers' supply (buyers bear ⅔ of economic burden of tax, while sellers bear a third)
when price ceilings are above the equilibrium price
they have no effect
If prices are free to adjust
eventually markets will be drawn to their equilibrium
For same tax added to market, the price sellers receive will
fall by less when supply is relatively more elastic
The larger the price elasticity of supply
the more sellers avoid the economic burden of the tax
Availability of substitutes determines
the price of elasticity of demand
Price of elasticity demand
% change in quantity demanded/% change in price
Price elasticity of supply=
% change in quantity supplied/% change in price
shopping
Markets migrating online=shopping may involve comparing prices across dozens of websites Above all→ outcomes determined by forces of supply and demand/same economic framework
Economic efficiency
An outcome is more economically efficient if it yields more economic surplus
Percent change in quantity demanded
=price elasticity of demand x percent change in price
price ceiling
A maximum price that sellers can charge/set by govp
Binding price floor
A price that prevents the market from reaching the equilibrium price, meaning that the lowest price that sellers can charge is above the equilibrium price Govs have diff reasons for setting binding price floors → sometimes they are trying to raise prices in order to help sellers
STEP 1-Is supply or demand curve shifting?
Any change affecting buyers or their marginal benefits will shift demand curve, while any change affecting sellers or marginal costs will shift supply curve
Market
A setting bringing together potential buyers and sellers sellers=suppliers/buyers=demanders
Increase in supply
A shift that increases the quantity supplied plan to sell at each price (shifts supply curve to right) Leads to a lower price and large quantity The new equilibrium occurs at a point where this new supply curve cuts the demand curve/new equilibrium price is lower than old one, and the new quantity is larger Increase in supply means managers want to sell more at old price, but buyers don't want to demand anymore If price didn't change, increase would result in surplus→ causes price to bid down End result=in an increase in supply causes a decrease in price and an increase in quantity
When the price is above the equilibrium price
A surplus leads to discounts, which push price down
Producer surplus area
Above the supply curve and below the price
Shifts in Demand
Any change that leads you to buy a large quantity at each price=increase in demand Buying smaller quantity at each price, decrease in demand *remember to go over factors that shift demand and supply curves
Total surplus across all buyers
Area under demand curve above the price
How will suppliers and demanders respond to shortage?
As long as shortage persists, you'll keep marking up your price
there are unintended consequences of price controls
Bc rent control results in people who can't find apartments→ landlords are often less responsive to requests for repairs bc they know they can find tenants easily If current tenants are unhappy f them→ thousands of other people willing to take over their lease No incentive for a landlord to do anything to improve an apartment if they can't charge a higher price for a nicer place Rent control may also change how landlords select their tenants
Social security statutory burden half by you half by employer
Bur workers ted to bear economic burden from social security taxes bc labor supply is fairly inelastic→ even if employers pay entire 12.4% not significant change in their take-home pay and employment wouldn't change Seems "fair" but politically motivated
Economic burden
Burden created by the change in after-tax prices faced by buyers and sellers Experiences greater loss as a result of the tax
planned economy
Centralized decisions are made about what is produced, how, by whom, and who gets what Cuba and the Soviet Union (to a lesser degree China)
STEP 3-How will prices and quantities change in the new equilibrium?
Compare old and new equilibrium
When consumers search more
Consumer search makes demand more elastic When consumers are willing to search for a low-cost alternative→ demand for product is more elastic Bc more you search for good deal, the more likely you are to find an acceptable lower-priced substitute Those most willing to search will be more responsive to price change
Economic surplus
Consumer surplus (marg ben-price) + producer surplus (price-marg cost)
Total economic surplus
Consumer surplus triangle + producer surplus triangle
quotas raise prices
Consumers want to purchase more housing/sellers want to sell more housing-the quota will be minding-meaning that the quota will determine quantity sold Competition among buyers for scarce goods leads them to pay higher prices If regulation is not binding→ won't affect market outcomes With a quota on sellers, resulting price will be determined by what buyers are willing to pay for limited quantity available With a quota on buyers, however, will lead to the price at which suppliers are willing to supply the restricted quantity that buyers demand
price ceilings on food in venezuela
Created a shortage of these essentials led to large black market for these goods
Decrease in demand leads to a lower price and a smaller quantity
Decrease in demand causes a reduction in both the equilibrium price and quantity→ There's decreased demand, but at the old price, no change in supply If price didn't change, a surplus would result Prospect of surplus leads the price to be bid down and that lower price incentive that leads suppliers to decrease quantity they supply as they move along their supply curve End result=a decrease in demand causes a decrease in both price and quantity
Why corn farmers are happier during droughts
Demand for corn is quite inelastic→ so quantity of corn demanded would only fall this much if the price of corn were to rise by far more Price of corn rose by a massive 33% → farmers sold 13% less corn at a price that's 33% higher so total revenue of corn farmers actually rose Hence when demand is inelastic a decrease in supply actually increases revenue
Demand examples
Demand for flights more elastic in airports near train stations bc train is substitute for flying Demand is more elastic for shorter flights for which driving is a reasonable substitute Demand more elastic when customers have option of flying united OR delta
tax incidence
Describes the division of the economic burden of a tax between buyers and sellers
Market Economy
Each individual makes their own productions and consumption decision, buying and selling in markets North America, Europe, Australia Prices and these prices provide incentives
Just like taxes, it doesn't matter who gets the subsidy
Economic benefit of subsidies is determined not by statutory burden but by price elasticities of demand and supply Meaning we wld get same outcome if government sent subsidy checks to child-care providers instead of sending them to parents Subsidy sent to providers wld shift supply curve to the right or down by the amount of the subsidy and the outcome wld be the same: new equilibrium quantity would be higher, buyers would pay less, and sellers would receive more in total, including the subsidy LAWS OF SUPPLY + DEMAND NOT LAWS SET BY GOV DETERMINE WHO BEARS ECONOMIC BURDEN OF A TAX + WHO GETS BENEFIT OF A SUBSIDY
consumer surplus
Economic surplus you get from buying something Consumer surplus=marg benefit-price
Efficiency and Equity
Efficiency criterion favors the outcome that yields most economic surplus
Equity is also important (but ignored by efficiency)
Equity An outcome yields greater equity if it results in a fairer distribution of economic benefits In reality=rare for new policies to compensate the people they harm Real world policy debates are rarely abt efficient/also focus on equity When you evaluate both efficiency and equity you'll account for both the size of the pie and how it's sliced
Supply elastic factor three: extra capacity makes supply elastic
Fixed inputs provide constraint on business's ability to expand production→ means that if a business is already using its fixed input at full capacity, it will be difficult to respond even if a business can easily access more of its variable inputs If has extra capacity→ supply will be more elastic Marcus huge kitchen=has extra capacity
Deadweight loss
How far economic surplus falls below efficient outcome / calculated by how much reduces economic surplus
Step 3 elaborate
How will prices and quantities change in the new equilibrium? Compare the pre-tax equilibrium with post-tax equilibrium One complication to remember with taxes: there are really two prices: the price the buyer pays and the price the seller receives Prices are after taxes so you have to distinguish which prices ur thinking abt
When there's more time to adjust
If gas prices stay high→ adjust plans over time so you drive even less Over time same price change will lead to a bigger change in quantity demanded Bc as time passes you will have more options to choose from/more substitutes become more available→ more substitutes=more elastic demand
Rule two
If prices and quantities move in opposite directions, supply curve has definitely shifted (possible demand curve shifted too)
Rule one
If prices and quantities move in the same direction, then the demand curve has definitely shifted (possible supply curve has also shifted)
Supply elastic factor two: Easily available variable inputs make supply elastic
If variable inputs you need to expand production are easily available, then supply will be more elastic You'll be able to increase production swiftly in response to a price rise Aka marcus' catering company can easily hire more workers and buy more supplies when price of catered meal rises As a result has flexibility to increase the quantity he supplies in response to a price rise
Supply elasticity factor one: inventories make supply more elastic
If your business's product is easily stored, then you can use inventories to provide the flexibility to respond quickly to price changes Aka oil refineries.can immediately dial up supply by selling storied inventories of gas when piece high/also can dial it back down by stockpiling inventories when price is low→ quantity supplied can respond rapidly to price changes, yielding more elastic supply Inventories provide flexibility by breaking the link between production and supply Allows you to adjust the quantity you supply even if it is difficult to adjust your production
STEP 2-Is that shift an increase, shifting the curve to the right? Or is it a decrease, shifting curve to left?
Increase in marginal benefit is an increase in demand, while an increase in marginal cost creates a decrease in supply
Quotas
Limit on maximum quantity of good that can be sold Can be on buyers→ for instance, many states have legalized marijuana limit the amount that people can buy per day Limits designed to reduced quantity sold by reducing demand quotas→ more frequently placed on suppliers Zoning laws effectively impose quotas→ limiting # of housing units that can be built
When the supply curve is completely horizontal
Means price of elasticity of supply is infinite-any change in price leads to an infinite change in quantity supplied Economists call this perfectly elastic supply
Price elasticity of supply
Measures how responsive sellers are to price changes Specifically measures by what percent the quantity supplied will increase following a 1% price change Larger this percent change in quantity supplied, more responsive sellers are to price changes
Cross Price Elasticity of Demand
Measures how responsive the quantity demanded of one good is to the price changes of another Specifically it measures the percent change in the quantity demanded following a 1% change in the price of another good Measure cross-price elasticity of demand as the ratio of the percent change in quantity demanded to the percent change in the price of another good
Income Elasticity of Demand
Measures how responsive your demand for a good is to change in your income Specifically measures by what percent the quantity demanded will change following a 1% change in income Measure elasticity of demand as ratio of the percent change in quantity demanded to percent change in income
For things that aren't necessities
Necessities have less elastic demand Things you really can't do without are things you will keep buying despite price food=necessity alternative to food is go hungry Help explains why demand is inelastic for food staples aka eggs, rice, pasta, fruits, veggies Restaurant meals=not necessity
Demand shifts lead price and quantity to move in the same direction
Notice that the equilibrium price and quantity both increase following an increase in demand and both decrease following a decrease in demand→ in both cases, shifts in demand cause price and quantity to change in same direction (not true for supply)
Decrease in supply
Opposite, shifts curve to left (don't confuse with movements along supply curve, when businesses change their quantity supplied in response to price change) Leads to a higher price and smaller quantity Decrease in supply causes an increase in the equilibrium price/decrease in quantity Decreased supply, but no change in demand→ if price didn't change this decreased supply would lead to shortage Prospect of shortage leads the price to be bid up, higher price is incentive that leads buyers to decrease the quantity they demand as they move along demand curve End result=a decrease in supply cause an increase in the price and a decrease in quantity
Equilibrium occurs at
POINT at which the market supply and demand curves cross→ point at which quantity supplied=quantity demanded
Subsidy
Payment made by the government to those who make a specific choice Gov uses subsidies to try to encourage consumption of certain goods & services like education
two extreme cases when slope clearly reveals elasticity
Perfectly elastic, Perfectly inelastic
Equilibrium
Point at which there is no tendency for change/a market in equilibrium when the quantity supply=quantity demanded Every seller who wants to sell an item can find buyer, ever buyer can find willing seller→ bc of this balance no tendency for market price to change when market is in supply-equals-demand equilibrium
Different demand elasticities measure the responsiveness of the quantity demanded to:
Price elasticity of demand-price of this good Cross-price elasticity of demand-price of another good Income elasticity of demand-income
Supply elastic factor five: Over time, supply becomes more elastic
Price elasticity of supply is typically larger when you're looking over a longer time horizon
Measuring Responsiveness of demand
Price of elasticity demand Measure of how responsive buyers are to price changes It measures the percent change in quantity demanded that follows from a 1% price change
POINT at which the market supply and demand curves cross→ point at which quantity supplied=quantity demanded
Prices are determined by both supply and demand You figure if something is essential, people must be willing to pay a lot for it→ but prices are determined by both supply and demand And when you think of supply or marginal cost side, you'll notice that water is plentiful/costs little to produce, while diamonds are scarce and expensive to mine
Equilibrium quantity
Quantity demanded and supplied in equilibrium Equilibrium occurs at POINT at which the market supply and demand curves cross→ point at which quantity supplied=quantity demanded Equilibrium reflects both supply and demand→ measured by both
Supply elastic factor four: Easy entry and exit makes supply more elastic
Quantity supplied in market also a function of the number of suppliers When the price rises, new business may enter the market/when falls some businesses may exit Market supply=more elastic when it is easier for business to enter or exit a market Flexibility to freely enter the catering market one of the key reasons that supply is quite elastic
Efficient outcomes hold the potential to make everyone better off
Relying on economic efficiency implicitly involves some difficult value judgments One argument for focusing on efficiency is that whenever economic surplus rises, it's possible for those who benefit to compensate those who were harmed and to so in way that ensures everyone better off
Mandate
Requires you to buy or sell a minimum amount of a good Health insurance mandate requires consumers to purchase health insurance A binding mandate on buyers increases quantity buyers demand Binding mandate on sellers increase quantity sellers supply
Price ceilings on prescription drugs in Canada
Result in fewer new drugs being available in Canada
Interpreting Market Data/Two key rules
Rule one/Rule two
Simple 3 step recipe that will help predict market outcomes
STEP 1-Is supply or demand curve shifting? STEP 2-Is that shift an increase, shifting the curve to the right? Or is it a decrease, shifting curve to left? STEP 3-How will prices and quantities change in the new equilibrium?
When price is below equilibrium price
Shortage leads to mark ups, pushes prices up
Efficient outcomes wont make everyone happy
Some policies help others, and then harm others Economic efficiency simply assesses whether economic surplus rises, only can occur if gains in economic surplus to those who are helped are larger than the declines in surplus among those who are harmed Ex: laws that allow uber to operate in your city probably raise economic surplus, even as they harm taxi drivers who face more competition Economic surplus higher bc overall benefits to uber drivers and passengers outweigh harm suffered by taxi drivers
For specific brands rather than broad categories
Specific brands to have more close substitutes, demand for these goods typically more elastic than broad categories Ex: honey nut cheerios so many substitutes/if price goes up many people will substitute for diff cereal/honey nut=elastic For broader categories like breakfast cereal, people are less responsive to price change bc demand is less elastic-eating something like cereal or yogurt is v different
A Three-Step Recipe for Evaluating Taxes
Step 1-Is this supply or demand curve shifting? Step 2-Is that shift an increase in taxes, shifting the curve to the left or a decrease shifting curve to right? Step 3-How will prices and quantities change in new equilibrium?
Insufficient parking spaces highlights 3 symptoms of a market out of equilibrium→ aka disequilibrium
Symptom 1: Queuing, Symptom 2: Bundling of extras Symptom 3: A secondary market
Step 2 elaborate
Taxes will typically shift the supply or the demand curve to the left bc they are a cost that reduces the marginal benefit for consumers when they are assigned the statutory burden of a tax and raises the marginal cost for sellers when they are the ones who are assigned to send in the tax A decrease in marginal benefit is a decrease in demand (a shift to left or down) On the supply side, an increase in marginal cost causes a decrease in supply (a shift to the left or up)
how does Determinants of the Price Elasticity of Demand relate to opportunity cost
Tells you that benefits of buying something→ u need to compare it to next best alternative It follows that price elasticity of demand is all about how good the next best alternative is-reflects the extent to which there are good substitutes available for marginal purchase
Statutory burden
The burden of being assigned by the government to send a tax payment (faced by sellers i think)
Producer surplus
The economic surplus you get from selling something/ = price-marginal cost
Equilibrium price
The price at which the market is in equilibrium ONLY ONE price
ant prie gouging laws
Those who support anti-price-gouging laws argue are a form of a price ceiling (means they do two things) Lead to a decrease in the quantity supplied an increase in the quantity demanded, thus creating shortages
Economic surplus
Total benefits minus total costs flowing from a decision Measures gains generated whenever something bought or sold
Price of elasticity of demand reflects the availability of substitutes
When there are more competing products More competing products there are, the more likely you are to find a close substitute you will be more price sensitive at walmart supercenter than at a small corner store Bc walmart has so many products→ u will be more likely to find a good substitute if the price of your first choice has gone up Usually 1 option at corner store
Examples of consumer surplus
Water/antibitoics/vaccinations
Price Floors
When Regulation Forces Higher Prices Opposite of price ceiling is price floor→ sets minimum price that can be charged When price floor set below equilibrium price, doesn't have any effect
Elastic
When the absolute value of the percent change in quantity is larger than the absolute value of the percent change in price, which means that the absolute value of price elasticity is greater than 1
Inelastic
When the absolute value of the percent change in quantity is smaller than the absolute value of percent change in price, which means that the absolute value if the price elasticity is less than 1 When buyers are not very responsive to price changes
Perfectly elastic
When the demand curve is completely horizontal it means that the price elasticity of demand is infinite-any change in price leads to an infinite change in quantity
Perfectly inelastic
When the demand curve is completely vertical it means that the price of elasticity of demand is zero-no matter what the change in price, the total quantity demanded is unchanged
Two forces pushing markets towards equilibrium
When the price is above the equilibrium price, When price is below equilibrium price
Shortages
When the quantity demanded exceeds quantity supplied Shortages lead to rise in prices When price is below equilibrium level→ shortage results/when gas is only 2 dollars per gallon, quantity of gas demanded far exceeds quantity supplied Too many people chasing too little gas Gas stations will sell out of gas/face long queues of desperate customers
Determinants of the Price Elasticity of Demand
When there are more competing products, For specific brands rather than broad categories, For things that aren't necessities, When consumers search more, When there's more time to adjust, Availability of substitutes
Symptom 1: Queuing
When you are driving around looking for spot, effectively queuing, waiting in line, for next available spot Extra time you spend in queue raises the effective price you're paying bc it'll cost you both time and money to get a spot
Symptom 2: Bundling of extras
When you bought dinner just so you get the valet to park your car→ effectively buying extras (that dinner) so you could get thing you wanted (parking spot) effectively raises price you're paying to park Also with videogames→ Buying a bunch of extra games bc video store will only sell you console if you do that
Symptom 3: A secondary market
When you parked in someone else's driveway→ you have found a way around "official" market for parking spots Secondary market also ebay/craigslist Each of these symptoms servies to raise the "effective price" even when the price charged by sellers can't directly rise
Other Demand Elasticities
Where interdependence principle comes into play
Efficient outcome
Yields the largest possible economic surplus Underlying logic is economic measures the size of pie, more pie better
You earn consumer surplus on all but
Your last purchase
Quantity regulation
a minimum or maximum quantity that can be sold
Inelastic demand means that war on drugs is losing battle
addiction=inelastic demand→ quantity demanded changes by very little even tho price is rising/drug users pay a lot more, but only consume a little bit less Inelastic demand means that the government's efforts to reduce the quantity of drugs on the street leads to higher revenues for drug dealers
Minimum wage debate
all about elasticity
prices determined
at margin/When u think of demand of water→ think about marginal benefit, not total benefit Total benefit of all water consumption=extraordinarily high, sustains life If price of water rose, wouldn't reduce the amount of water you drink, but maybe shorter showers/don't water lawn as often thus→ marginal gallon of water is inessential Willingness to pay for a gallon of water is low, because marginal gallon bring little marginal benefit BUT if water were ever to become so scarce that the marginal gallon would save you from dehydration, willingness to pay for one more gallon of water wld be so high as to make water more valuable than diamonds
What happened when gov levies a tax is
buyers buy less, sellers sell less and prices are higher for buyers and lower for sellers→ tax matters but who has statutory burden doesn't matter
When demand is more elastic relative to supply
buyers capture less of a subsidy/Sellers capture more of the subsidy when their supply is inelastic
Tax increases the price
buyers pay and decreases the price sellers receive For ex: figure 2 shows that sellers' price declines from 1.10 to 1.00 Price received by sellers has fallen by .10 per soda But price buyers pay has risen from 1.10 to 1.30 (1.00 soda + .30 tax) so the after-tax cost of a 20 ounce soda has risen by .20 Buyers and sellers bear the economic burden of a tax on buyers
Increase in demand leads to higher price and a larger quantity
buyers want to buy more at the old price, but sellers don't want to supply more If price doesn't change→ shortage results Prospect of shortage leads the price to bid up→ higher price is incentive that leads suppliers to increase quantity they supply as they move along their supply curve End result=increase in demand causes increase in both price and quantity
price ceilings that are below the equilibrium price
cause shortages
Cross-price elasticity is negative for
complements When goods are complements quantity demanded falls in response to a rise in price of another good Printers and printer cartridges→ when price of a printer rises, people buy fewer printers→ less likely to own printer less likely to buy cartridges
When quantity is very responsive
demand is elastic Uber found riders v responsive to prices→ when cut prices, the quantity of rides demanded rose by an even greater percentage When buyers responsive to price=elastic
Buyers bear a smaller share of the economic burden when
demand is relatively elastic As a consumer→ u can avoid soda tax by buying few sodas The more you reduce the quantity you demand in response to a tax-induced price hike, thee more you are effectively avoiding the tax, leaving sellers to pay more
Positive analysis
describes what is going to happen /Describes what is happening, explaining why, or predicting what will happen
Sellers bear a smaller share of the
economic burden when supply is relatively elastic If you're a seller only way to avoid a tax hike is to supply a smaller quantity Sellers experience a tax hike as a reduction in the after-tax price they receive Sellers avoid a tax by decreasing the quantity they supply as the after-tax price they receive falls remember=key to elasticity of supply is how flexible seller is
Remember elasticity is not the same thing as slope
elasticity is given by percent change→ while linear demand curves have the same slope all along the curve, the elasticity will differ along curve
Price elasticity of supply reflect
how willing businesses are to increase the quantity supplied in response to a higher price Price of elasticity of supply is all about flexibility Your business's flexibility is the underlying determinant of your price elasticity of supply Describes how easily and cheaply you can mobilize resources to expand production when prices rise/how easily can cut your expenses repurpose resources when price falls more flexible, greater your price elasticity of supply will be
When the supply curve is completely vertical
in price, and the total quantity supplied is unchanged =perfectly inelastic supply
Tax leads to a decline
in quantity sold Shift in supply results in new supply curve intersecting the demand curve at a lower quantity demanded End result is that higher soda prices lead to lower soda sales bc each bottle of soda costs consumers more
ncome elasticity of demand is negative for
inferior goods Bc quantity of inferior goods you consume moves in the opposite direction of your income, their income elasticity of demand is negative
Determinants of Price Elasticity of Supply
inventories make supply more elastic, Easily available variable inputs make supply elastic, extra capacity makes supply elastic, Easy entry and exit makes supply more elastic, Over time, supply becomes more elastic
Subsidy is a
is a negative tax since it operates just like a tax but with the opposite sign Subsidies increase the quantities demanded and supplied, and they tend to lower the price buyers pay and increase price sellers receive Just like tax→ outcomes don't depend on statutory assignment of the subsidy Benefit of subsidies shared between buyers and sellers What determines distribution of subsidy between buyers and sellers? → price elasticities of demand and supply
*When absolute value of the price elasticity of demand is exactly equal to 1
it is neither elastic nor inelastic=unit elastic
If the price is falling
likely the quantity supplied exceeds the quantity demanded
Absolute value focuses on
magnitude of price of elasticity demand |elasticity| Useful bc an elasticity of -5 means a bigger percent change in demand that would occur if elasticity was -.5 Focusing on absolute value makes it easier to talk abt magnitude of change Simply say larger elasticity means a larger percent change in the quantity demanded
Tax represents
marginal cost to sellers bc it's an additional cost they must pay for each unit they sell When marginal cost increase, supply curve shifts (interdependence principle in action) Since supply curve is marginal cost curve, if marginal costs are .30 higher then the supply curve must shift .30 up
That is cross-price elasticity of demand=
percent change in quantity demanded/percent change in price of another good
When supply is relatively more inelastic
means that a larger increase in price is needed to induce sellers to increase the quantity supplied to the level that buyers want
Calculating the Price Elasticity of Supply
midpoint formula?
price floor
minimum price that sellers can charge
when supply is relatively more inelastic sellers bear
more of the economic burden of the tax and therefore see a larger decline in the after-tax price
Notice that the price elasticity of demand is a
negative number bc cutting price raise quantity demanded/Law of demand→ tells us price goes up, q goes down and vice versa
Income elasticity of demand is positive for
normal goods Change in demand goes in same direction as change in income Magnitude of income elasticity of demand tells us by how much *necessities tend to have small income elasticity for many of the same reasons that their price elasticity of demand is inelastic
To measure price elasticity of demand
observe how quantity demanded responds to a price change
taxi fares
often set by local government when fares are set too low it can be hard to get cab
income elasticity of demand=
percent change in quantity demanded/percent change in income
Price elasticity of supply is
positive Changes in price lead to changes in quantity supplied in the same direction as you move along a supply curve Raising the price increases the quantity supplied/lowering price reduces the quantity supplied A bigger value of the price elasticity of supply means that the quantity is more responsive to price changes
usury laws
prevent payday loan companies from charging excessively high interest rats Mean that sometimes companies will refuse to make any loans at all if they can't charge high enough interest rates
binding price ceiling
prevents the market from reaching the market equilibrium price, meaning that the highest price sellers can charge is set below the equilibrium price w
Supply shifts lead
price and quantity to move in opposite direction
The tax increases the
price buyers pay and decreases the price sellers receive New price of 1.30 is price u pay at register but it isn't amount that sellers keep bc they have to send .30 per bottle to gov in taxes
Tax incidence depends on
price elasticity of demand epends on your ability to avoid taxes→ the more that you can avoid the tax, the less of it you will pay (and thus the lower your economic burden) Way to avoid tax is not to buy or sell things that are taxed Since taxes causes prices to change, makes sense that the price elasticities of demand & supply determine who is best able to avoid a tax
minimum wage is a
price floor-it's a minimum price that can be charged for an hour of work Governments typically set minimum wages in order to raise the wages received by lowest-wage workers/fact that quantity demanded declines=undesirable side effect Other times govs explicitly trying to reduce the quantity sold Ex: govs have set min prices for alcohol to reduce consumption These two goals reflect fact that a price floor does two things: it raises prices and it lowers the quantity sold Reduce quantity of alc sold by setting min price (aka price floor)
Total revenue
price x quantity total amount you receive from buyers
auction
price you pay depends on how much other bidders forced you to raise
Coffee shop
prices are posted→ simply pay price and go
How markets are organized
prices posted, price demands on other bidders, financial market, online marrket
Tax leads to a decline in the
quantity sold New demand curve intersects supply curve at a lower quantity suppliedin the quantity sold
while an inelastic demand curve is
relatively steep
Cross-price elasticity is positive for
substitutes When goods are close substitutes aka cars and public transportation→ people tend to buy more of a good when the price of its substitute increases Coke and pepsi tend to be priced same Cross-price elasticity of substitutes is always positive→ you buy more coke when price of pepsi goes up Magnitude of cross-price elasticity tells you how sustainable the two goods are
Quantity is relatively responsive when
supply is elastic When suppliers are responsive to price, economists describe supply as elastic Supply elastic whenever magnitude of the percent change in quantity supplied is large than the percent change in price/means supply is elastic if price of elasticity of supply is larger than q
Quantity is relatively unresponsive when
supply is inelastic When suppliers can't increase the quantity supplied by much in response to higher prices, economists describe supply as inelastic Whenever magnitude of percent change in q supplied is smaller than the percent change in price (less than 1)
In the extreme, when price elasticity of demand is zero-meaning
that a subsidy leads to no change in demand, then buyers will capture the entire subsidy
Price of elasticity of demand reflects
the availability of substitutes (all abt sustainability)
Whenever two demand curves pass through the same point
the demand curve that's flatter at that point is the more elastic demand curve
both buyers and sellers bear
the economic burden of the tax non sellers
Surpluses lead the price
to fall (quantity demanded less than quantity supplied) When gas is $4 a gallon, surplus results as quantity of gas supplied far exceeds quantity demanded Gas owners trying to sell off their unsold gas will charge lower prices in hopes of attracting more customers With enough competition→ repeated rounds of discounting will push price down, eliminating surplus
Higher prices lead to less
total revenue if demand is elastic When demand is elastic→ higher price yields less revenue If customers responsive to price change, modest price rise will lead to a large decline in quantity demanded
Higher prices lead to more
total revenue if demand is inelastic If customers don't respond much to price changes, then even a large price increase will lead to only a small decline in quantity demanded, which means your total revenue will be higher If percent rise in price is larger in magnitude than the percent decline in quantity demanded, then a price rise will cause your total revenue to increase
instances of price ceilings
usury laws, taxi fare, price ceilings on prescription drugs in candy & price ceilings on food in venezuela + concept of repugnance
Sign of cross price elasticity of demand tells you:
when it's positive→ means you buy more of a good when the price of another good goes up When it's negative→ you buy less What determines if you buy more or less? If goods are substitutes or complements
First step to analyzing price regulation is to ask
whether regulation is binding At higher price established by price floor, quantity demanded is less than the quantity supplied One form of surplus=unemployment Minimum age establishes a price floor and as we know when price floor is binding, quantity supplied will exceed quantity demanded (employers more willing to hire people at minimum wage)
If demand for your product is currently inelastic
you should raise your prices Will also decrease your costs, bc when you charge a higher price you need to produce a smaller quantity→ result is that if demand for your product is inelastic, then increasing your prices increases your profits
