ECO 105 1nd Edition Lecture 8Outline of Last Lecture I. Applications of Supply and DemandOutline of Current Lecture I. SubsidyII. TaxIII. Price Elasticity of DemandCurrent LectureI. Subsidya.i. Pp – Pc = xii. Qx * x = total subsidy1. Qx(Pp – Pc) = total subsidyb.i. A + B + D + E = CSii. A + C + D + F = PSThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.iii. A + C + D + E + G = total subsidyiv. G = DWLv. (CS + PS) – total subsidy = social welfare1. A + B + D + E + A + C + D + F – (A + C + D + E + G) = SWa. A + B + D + F – G = SWvi. The government subsidy caused a deadweight lossII. Taxa.i. Pc – Pp = Tii. Before:1. CS = A + B + C2. PS = D + E + Fiii. After: 1. CS = A2. PS = F3. B & D go to governmenta. Revenue = T * QT = B + D4. DWL = C + EIII. Price Elasticity of Demanda. Definition = the percentage change in Q when price increases by 1%b. eQ,P = %∆Q/%∆P = [(Q2 – Q1)/Q1]/[(P2 – P1)/P1]c. EXAMPLE: Subway sandwichi. Suppose P1 = $5, P increases to $6, Q1 = 100, Q2 = 50ii. [(50-100)/100]/[(6-5)/65] = -2.5 (quantity decrease)iii. ANSWER: The price elasticity of demand eQ,P = -2.5d. EXAMPLE: tax of gasolinei. Gasoline = $4, Americans buy 1 billion gallons/day, government imposes $1/gallon tax, eQ,P = -0.5ii. %∆Q = %∆P * eQ,P%∆P = (5-4)/4 = 0.25 or 25%25% * -0.5 = %∆Q%∆Q = -12.5% <-- how much sale of gas will decrease per day1 billion - 0.125(1 billion) = 875 million gallons --> $875 million/daye. eQ,P < 1, inelasticf. eQ,P > 1, elasticg. Income elasticityi. eQ,y = the %∆Q when income “y” increases 1%1. Can be positive or negative depending on the goodii. EXAMPLE1. $10,000 income increase, buy less Ramen, more Ferrarisiii. eQ,y < 0, inferioriv. eQ,y > 0, normalh. eQ,Po = the %∆Q when price Po of some other related good increases 1%i. PB & J = complements1. eQ,Po < 0 PB price increases, jelly quantity (demanded) decreasesii. Hamburgers & hot dogs = substitutes1. eQ,Po > 0 hamburger price increases, hotdog quantity (demanded)