MSU EC 201 - Chap6 (31 pages)

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Chap6



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Chap6

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Pages:
31
School:
Michigan State University
Course:
Ec 201 - Introduction to Microeconomics
Introduction to Microeconomics Documents
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Krugman and Wells Chapter 6 Steven J Haider EC201 Spring 2015 Overview Chaps 3 5 lay out how competitive markets work Chap 3 shifting S D Chap 4 welfare Chap 5 price and quantity controls This chapter how much do prices and quantities change Depends on the slopes of S and D and how much they shift We measure these features with elasticities Note I cover the same material in the chapter but take a pretty different tack Caution if you are uncomfortable with math this week may look daunting Let us help you It isn t that bad p2 Example 1 daily sandwich demand P P 6 5 D1 220 250 D2 Q At 5 you sell 250 for daily revenue of 1250 At 6 you sell 220 for daily revenue of 1320 Maybe no close substitutes nearby 50 250 Q At 5 you sell 250 for daily revenue of 1250 At 6 you sell 50 for daily revenue of 300 Maybe another sandwich shop nearby You are a pastrami shop owner on Grand River You re thinking about raising your price from 5 to 6 Should you p3 Example 1 daily sandwich demand P P 6 5 D1 220 250 D2 Q At 5 you sell 250 for daily revenue of 1250 At 6 you sell 220 for daily revenue of 1320 Maybe no close substitutes nearby 50 250 Q At 5 you sell 250 for daily revenue of 1250 At 6 you sell 50 for daily revenue of 300 Maybe another sandwich shop nearby You are a pastrami shop owner on Grand River You re thinking about raising your price from 5 to 6 Should you p4 Example 2 recession and groceries P P 4 D2 Milk D1 D2 Q Quantity drops a little Recession causes income to decline and milk is a normal good Perhaps small shift in demand milk is central to the diet of many D1 Q Dove ice cream bars Quantity drops a lot Recession causes income to decline and Dove bars are a normal good Perhaps large shift in demand pretty easy to do without If you are a grocer it may be very useful to know how buying patterns change over the business cycle p5 Example 2 recession and groceries P P 4 D2 Milk D1 D2 Q Quantity drops a little Recession causes income to decline and milk is a normal good Perhaps small shift in demand milk is central to the diet of many D1 Q Dove ice cream bars Quantity drops a lot Recession causes income to decline and Dove bars are a normal good Perhaps large shift in demand pretty easy to do without If you are a grocer it may be very useful to know how buying patterns change over the business cycle p6 Example rent controls P P S S D D Q A binding price ceiling is implemented Large decline in apartments rented Perhaps lots of alternative uses for land including conversions to condos Q A binding price ceiling is implemented Small decline in apartments rented Perhaps apartments land are not suitable for other uses What would happen if a city council adopted a rent control policy p7 Example rent controls P P S S D D Q A binding price ceiling is implemented Large decline in apartments rented Perhaps lots of alternative uses for land including conversions to condos Q A binding price ceiling is implemented Small decline in apartments rented Perhaps apartments land are not suitable for other uses What would happen if a city council adopted a rent control policy p8 Elasticity The responsiveness of one variable to another Ultimately economics is trying to make predictions about how the world works how much is an important part of this The words are meant to be descriptive Two pictures of me trying equally hard to stretch a 1 foot blue hose Inelastic garden hose stretches a little Elastic surgical tubing stretches a lot p9 Elasticity the general form Elasticities we will work with in EC201 Own Price Elasticity of Demand Cross Price Elasticity of Demand Income Elasticity of Demand Price Elasticity of Supply Basic formula means change or difference B A Elasticity of B A Example Q D Price Elasticity of Demand P A B p10 Remember pastrami example Price Elasticity of Demand PED Measures the responsiveness of quantity demanded to price changes Very much related to the slope of the demand curve Absolute statements about responsiveness Elastic PED 1 P causes big Q Unit PED 1 P causes equal Q Inelastic PED 1 P causes small Q P P 10 Q Q 0 Q 4 Q 10 Q 20 Q PED 0 PED 4 PED 1 PED 2 PED Perfectly Inelas Inelastic Unit Elastic Elastic Perfectly Elas p11 Price Elasticity of Demand PED Measures the responsiveness of quantity demanded to price changes Very much related to the slope of the demand curve Absolute statements about responsiveness Elastic PED 1 P causes big Q Unit PED 1 P causes equal Q Inelastic PED 1 P causes small Q Just like stretching the hose Q stretches a lot with a given p the force elastic P stretches a little with a given Q P 10 p the force inelastic Q Q 0 Q 4 Q 10 Q 20 Q PED 0 PED 4 PED 1 PED 2 PED Perfectly Inelas Inelastic Unit Elastic Elastic Perfectly Elas p12 Example vaccine demand 6 1 What is the price elasticity of demand PED if we drop price from 21 to 20 Q D Q2D Q1D Q1D P P2 P1 P1 Q dropped a little compared to P increase 10 9 9 9 9 20 21 21 010 048 0 208 The convention regrettably is to report PED as 0 208 drop negative because it must be negative the law of demand p13 One complication Standard definition of percent change with Price Elasticity of Demand Q D Q2D Q1D Q1D P P2 P1 P1 For B to A Q D 10 9 9 9 9 0 208 P 20 21 21 For A to B Q D 9 9 10 10 0 200 P 21 20 20 A to B vs B to A differs p14 Resolution use average in denom It would be real nice if we could have the same number for both NOTE when you use calculus in EC301 this problem doesn t exist This is called the Mid Point Formula PED Q Q Average Q D 2 D 1 P2 P1 Average P Q Q D 2 D D 1 P2 P1 Q Q 2 D 1 D 2 P1 P2 2 p15 Summary use these formulas If you are given individual data points midpoint A Elasticity of B B2 B1 Average B A2 A1 Average A B2 B1 A2 A1 B1 B2 2 A1 A2 2 If you are given percentage changes directly B A Elasticity of B A only take the absolute value for the price elasticity of demand p16 Example PED s from the real world Examples Goods that are necessities or do not have good substitutes tend to have inelastic demand Relative statements about responsiveness More inelastic means smaller …


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