ECO2030 1st Edition Lecture 13 Outline of Last Lecture I Examples of price elasticity of supply Outline of Current Lecture II III IV V VI Income elasticity of demand Cross price elasticity of demand Government policies that alter the private market outcome Price Ceilings Price Floors Current Lecture Other Elasticities Income Elasticity of demand Income elasticity of demand Qd income remember that an increase in income causes an increase in demand for NORMAL goods but a decrease in demand for INFERIOR goods Therefore normal goods have an income elasticity 0 and Inferior goods have and income elasticity 0 Cross price elasticity of demand Measures how much demand for one good changes with an increase of price of another good compares goods Cross price elasticity of demand Qd of good 1 P of good 2 for substitutes cross price elasticity of demand 0 e g an increase in the price of coca cola means there will be an increase in demand for Pepsi For compliments cross price elasticity of demand 0 e g an increase in the price of smartphones causes a decrease in demand for smartphone cases Summary What is really important to remember is that calculating Price elasticity Quantity demand is always on top When demand is elastic revenue falls when prices are raised coca cola When demand is inelastic revenue rises when prices rise insulin Demand is less elastic in the short run for necessities for broadly defined goods and goods with few or no substitutes Supply is less elastic in the short run Price elasticity of supply is elastic when it is 1 Price elasticity of supply is inelastic when it is 1 Chapter 6 Government policies that alter the private market outcome Price controls Price ceilings limits suppliers price a legal maximum price Price floor a legal minimum cannot reduce price below this amount e g minimum wage Taxes buyers or sellers can pay the tax We will learn how buyers and sellers share the tax Price controls rent control example Motivation you want to keep the price low so people who work there can have a place to live you don t want big investors buying it up Price of apartments in the graph on the right you can see that a price ceiling above at or above 800 has no effect on the market However with a price ceiling at 500 below the equilibrium point the ceiling is a binding constraint This will cause a shortage Sellers of Apt s may start converting apts to retail space etc in order to maximize profits Note how the supply curve cannot meet the demand and because the price is lower demand increases the shortage is between 250 and 400 so the total shortage 150 In the long run supply and demand are more price elastic so shortage is larger A quick methods to clarify whether a price floor or price ceiling is a binding constraint or not use the arrows to help yourself understand on which side of the line the constraints would occur Example 2 the market for unskilled labor W Wage paid to unskilled workers L Quantity of unskilled workers Not a binding constraint because equilibrium is naturally above price floor this one is a binding constraint which results in a labor surplus unemployment because the equilibrium is below the price floor Note that the demand decreases and the supply increases because more people are eager to work with higher wages this creates unemployment of 150 people in this case
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