ECO2030 1st Edition Lecture 13Outline of Last Lecture I. Examples of price elasticity of supplyOutline of Current Lecture II. Income elasticity of demandIII. Cross-price elasticity of demandIV. Government policies that alter the private market outcomeV. Price Ceilings VI. Price FloorsCurrent LectureOther ElasticitiesIncome Elasticity of demand Income elasticity of demand = (ΔQd)/(Δincome)● 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 <0Cross-price elasticity of demandMeasures how much demand for one good changes with an increase of price of another good (compares goods)Cross-price elasticity of demand = (ΔQd of good 1)/( (ΔP 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 demandfor 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 <1Chapter 6:Government policies that alter the private market outcomePrice 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 sellersshare the taxPrice controls - rent control example● Motivation: you want to keep the price lowso people who work there can have a placeto live, you don't want big investors buying itup.Price of apartments● in the graph on the right you can see that aprice ceiling above at or above $800 has noeffect on the market.● However, with a price ceiling at $500 (belowthe equilibrium point) the ceiling is a bindingconstraint. ● This will cause a shortage. Sellers of Apt’smay start converting apts to retail space etc,in order to maximize profits.● Note how the supply curve cannot meet thedemand, and because the price is lower,demand increases, the shortage is between250 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 pricefloor or price ceiling is a binding constraintor not, use the arrows to help yourselfunderstand on which side of the line theconstraints would occurExample 2: the market for unskilled laborW = Wage paid to unskilled workersL = Quantity of unskilled workers● Not a binding constraint because equilibriumis naturally above price floor● this one is a binding constraint which resultsin a labor surplus (unemployment) becausethe equilibrium is below the price floor. ● Note that the demand decreases and thesupply increases because more people areeager to work with higher wages. this createsunemployment of 150 people in this
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