Working with Demand and Supply Price CeilingsFigure 1: A Price Ceiling in the Market for Maple SyrupPrice FloorsFigure 2: A Price Floor in the Market for Nonfat Dry MilkLimiting SurplusSupplier’s perspectiveThe Demand Schedule Demand for Maple SyrupSlide 8The Problem with Rate ChangeThe Elasticity ApproachCalculating Price Elasticity of DemandFigure 3: Calculating Price Elasticity of DemandAn Example: Calculating Price Elasticity of DemandElasticity and Straight-Line Demand CurvesFigure 4: Elasticity and Straight-Line Demand CurvesCategorizing Goods by ElasticitySlide 17Figure 5: Extreme Cases of DemandElasticity and Total RevenueSlide 20Slide 21Figure 6: Elasticity and Total ExpenditureAvailability of SubstitutesNarrowness of MarketNecessities vs. LuxuriesTime HorizonImportance in the Buyer’s BudgetUsing Price Elasticity of Demand: The War on DrugsFigure 7a: The War on DrugsFigure 7b: The War on DrugsFigure 7c: The War on DrugsUsing Price Elasticity of Demand: Mass TransitUsing Price Elasticity of Demand: An Oil CrisisIncome Elasticity of DemandSlide 35Slide 36Slide 37Cross-Price Elasticity of DemandPrice Elasticity of SupplySlide 40Slide 41Figure 8: Extreme Cases of SupplyThe Tax on Airline Travel: Taxes and Market EquilibriumFigure 9a: The Tax on Airline TravelFigure 9b: The Tax on Airline TravelFigure 10: Effect of Excise Tax on AirlinesTax Incidence and Demand ElasticityFigure 11: Tax Incidence and Demand ElasticityTax Incidence and Supply ElasticityFigure 12: Tax Incidence and Supply ElasticityThe Market For FoodFigure 13: The Market For FoodHealth Insurance and the Market for Health CareFigure 14: The Market For Health Care With CoinsuranceHall & Leiberman; Economics: Principles And Applications, 2004 1Working with Demand and Supply Price Ceilings•Government-imposed maximum price that prevents the price of a good from rising above a certain level in a market•Short side of the Market prevails•Price ceiling creates a shortage–While the price decreases, the opportunity cost may rise•Black Market–A market created by unintended consequences of government intervention•Goods are sold illegally at a price above the legal ceilingHall & Leiberman; Economics: Principles And Applications, 2004 2Figure 1: A Price Ceiling in the Market for Maple Syrup60,00050,00040,000TEVRDS$4.003.002.002. increases quantity demanded3. and decreases quantity supplied.4. The result is a shortage – the distance between R and V.Number of Bottles of Maple Syrup per PeriodPrice per Bottle1. A price ceiling lower than the equilibrium price . . .5. With a black market, the lower quantity sells for a higher price than initially.Hall & Leiberman; Economics: Principles And Applications, 2004 3Price Floors•Government imposed minimum amount below which price is not permitted to fall–Price floors for agricultural goods are commonly called price support programs•When sellers produce more of the good than buyers want at the price floor –Remaining goods become a surplus that no one wants at the imposed price•Government responds by maintaining price floors –Uses taxpayer dollars to buy up entire excess supply of the good in question–Prevents excess supply from doing what it would ordinarily do•Drive price down to its equilibrium valueHall & Leiberman; Economics: Principles And Applications, 2004 4Figure 2: A Price Floor in the Market for Nonfat Dry Milk2. decreases quantity demanded . . .200180 220$0.810.65KJSDA4. The result is a surplus the – distance between K and J – which government must buy.Millions of PoundsPrice per Pound1. A price floor higher than the equilibrium price . . .3. and increases quantity supplied.Hall & Leiberman; Economics: Principles And Applications, 2004 5Limiting Surplus•A price floor creates a surplus of goods–In order to maintain price floor, government must prevent surplus from driving down market price•Government often accomplishes this goal by purchasing surplus with taxpayers dollars•Price floors often get government deeply involved in production decisions–Rather than leaving them to the marketHall & Leiberman; Economics: Principles And Applications, 2004 6Supplier’s perspective•A producer considers increasing his price•Is it a good idea?•Higher price means more revenue per unit output BUT…•Lower units of quantity sold (downward sloping demand).Hall & Leiberman; Economics: Principles And Applications, 2004 7The Demand ScheduleDemand for Maple SyrupPrice (per bottle) Quantity Demanded (bottles per month)$1.00 75,000$2.00 60,000$3.00 50,000$4.00 35,000$5.00 20,000Hall & Leiberman; Economics: Principles And Applications, 2004 8The Demand ScheduleDemand for Maple SyrupPrice (per bottle)Quantity Demanded (bottles per month)Revenue (price times quantity) $1.00 75,000 $75,000$2.00 60,000 $12,000$3.00 50,000 $150,000$4.00 35,000 $140,000$5.00 20,000 $100,000Hall & Leiberman; Economics: Principles And Applications, 2004 9The Problem with Rate Change•Rate of change of quantity demanded compared to the change in price is not a good measure of price sensitivity–Doesn’t tell whether a change in price or a change in quantity demanded is a relatively large or relatively small change•Relative means compared to value of price or quantity before changeHall & Leiberman; Economics: Principles And Applications, 2004 10The Elasticity Approach•Elasticity approach improves on the problems with rate of change –By comparing percentage change in quantity demanded with percentage change in price•Price elasticity of demand (ED) for a good is percentage change in quantity demanded divided by percentage change in price–Will virtually always be a negative number–Tells us percentage change in quantity demanded for each 1% increase in price•Price elasticity of demand tells us percentage change in quantity demanded caused by a 1% rise in price as we move along a demand curve from one point to anotherP%Q%EDDHall & Leiberman; Economics: Principles And Applications, 2004 11Calculating Price Elasticity of Demand•When calculating elasticity base value for percentage changes in price or quantity is always midway between initial value and new value–When price changes from any value P0 to any other value P1, we define the percentage change in price as2)()( Price in Change %PPPP0101–When quantity demanded changes from Q0 to Q1, percentage change is calculated as2)_(
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