ECON 202 1st Edition Exam 2 Study Guide Module 13 Price controls Ceilings and Floors Price Controls Mandated minimum or maximum prices a Price Ceiling a maximum price benefits those on the Demand Curve b Price Floor a minimum price benefits those on the Supply Curve Explain how price controls create problems and can make a market inefficient a Price controls can create problems and can make a market inefficient in a variety of ways b A price ceiling can cause inefficiencies in the market by i Low Quantity the price ceiling has artificially limited the quantity the actual quantity will be set by the suppliers ii Low Quality the product ends up being lower quality iii Consumer Allocation the consumers do not receive the goods in an efficient manner iv Wasted Resources v Black Market Activity the government mandate leads people to finding ways around them whether it is illegal or not vi Price Ceilings can also cause surpluses in the market because there is more supply than is demanded vii Price Ceilings also create deadweight loss c A price floor can cause inefficiencies in the market by i Low Quantity ii High Quality market gets flooded with high goods because you cant keep paying for lower quality iii Seller Allocation iv Wasted Resources v Black Market Activity Module 14 Quantity controls Quotas Quantity Controls Quota is an upper limit on the quantity of some good that can be bought or sold an alternative to controlling price is controlling quantity of goods A quantity control or quota drives a wedge between the demand price and the supply price of a good that is the price paid by buyers ends up being higher than that received by sellers The difference between the demand and supply price at the quota limit is the quota rent the earnings that accrue to the license holder from ownership of the right to sell the good It is equal to the market price of the license when the licenses are traded How can quantities controls create problems and can make a market inefficient a Quantity Controls can cause inefficiencies in the market by i Leading to illegal activity ii A quota drives a wedge between the demand price and the supply price this wedge is equal to the quota rent iii Deadweight loss is what makes the market become inefficient iv It also encourages illegal activity as well Predict who benefits and who loses from quantity controls and explain why they are used despite their well known problems a When a price ceiling is installed people whom benefit from using quantity controls are successful buyers because the price maximum creates shortages b Price floors benefit successful sellers or producers because it prevents dumping and protects a minimum profit to producers c Quantity controls are still used despite their well known problems because in strict situations where a limit is needed the controls can enforce them Such policies trade off lower expected costs in favor of strict control of emissions in all possible outcomes d Quantity controls can be used to avoid crossing the threshold and in this case large expenditures in order to meet the target are justified by the dire consequences of missing it Module 8 Elasticity Elasticity a measure of responsiveness to changes in prices or incomes The importance of the price elasticity of demand ED Change in Quantity Change in Price The Midpoint Method Module 9 Interpreting Price Elasticity of Demand Elastic and Inelastic Demand Elastic demand means that demand for a product is sensitive to price changes For example if the selling price of a product is increased there will be fewer units sold If the selling price of a product decreases there will be an increase in the number of units sold Inelastic Demand whose percentage change is less than a percentage change in price For example if the price of a commodity rises twenty five percent and demand decreases by only two percent demand is said to be inelastic The relationship between elasticity and total revenue when does TR increase or decrease when you have a price rise or fall If your product has elastic demand you can increase your revenue by decreasing the price of that good P will decrease but Q will increase at a greater rate thus increasing total revenue If the product is inelastic then you can actually raise prices sell slightly less of that item but make higher revenue Calculate changes in the price elasticity of demand along a demand curve The price elasticity of demand PED explains how much changes in price affect changes in quantity demanded Elastic PED can be interpreted as consumers being very sensitive to changes in price Inelastic PED can be interpreted as consumes being insensitive to changes in price Firms use PED to figure out how to change their prices in order to increase revenue PED varies along a straight demand curve Change in Quantity Demanded Change in Price Factors that determine Price Elasticity of Demand 1 Are there close substitutes a Is there something else you could get instead of that good i Yes Elastic No Inelastic 2 Necessity or Luxury a Necessity Inelastic Luxury Elastic 3 Share of Income Spent on the Good a A lot Elastic Little Inelastic 4 Time a More time Elastic Less Time Inelastic How does elasticity impact the burden of taxation If demand is more inelastic than supply firms will be able to pass more of the tax onto consumers if supply is more inelastic than demand firms will have to bear more of the burden of the tax Module 10 Other Elasticities Identify how the cross price elasticity of demand measures the responsiveness of demand for one good to changes in the price of another good Cross Price Elasticity of Demand measures the responsiveness of the demand for one good to the changes in the price of another good C P of Demand can be calculated by Change in Quantity Demanded of Good 1 Change in Price of Good 2 Depending on whether the cross price elasticity of a good is positive or negative we can determine if the goods are complements or substitutes If two products are complements it can be noted that an increase in demand will lead to a second increase in demand for the other good A positive cross price of elasticity notes that two goods are substitutes A negative cross price of elasticity notes that two goods are complements When the cross price elasticity is zero the two goods are independent of each other Income Elasticity of Demand measures the responsiveness of demand to changes in income ceteris paribus Normal goods have a positive income