5 Elasticity and its Application Economics Exam 2 Elasticity how much one variable responds to changes in another variable Ex How much demand for your websites will fall if you raise your price gasoline has very elastic supply Demand how much quantity demanded responds to a change in price higher in the long run substitute more over time Goods with substitutes have a more elastic demand Butter vs Eggs Necessities vs Luxuries Narrow vs Broad Price Elasticity of Demand change in demanded change in Drop negative signs P E D btwn 2 points Q2 Q1 Q2 Q1 2 P2 P1 P2 P1 E 1 then demand is elastic E approaches horizontal curve Higher the elasticity the flatter the curve E 1 then demand is inelastic E 0 then demand is perfectly inelastic vertical curve E 1 demand has unit elasticity total revenue stays constant when price changes Total Revenue amount paid by buyers and received by sellers of a good P X Q Demand is Elastic increase in price decrease in total revenue Demand is Inelastic inccrease in price increase in total revenue Income Elasticity of Demand measures how the quantity demanded changes as the consumer income changes IED change in demanded change in income Normal Goods higher income higher demand Inferior Goods higher income less demand Positive income elasticity Food clothing Negative income elasticity Bus rides Cross Price Elasticity of Demand measures how quantity demanded of one good responds to change in the price of another good C P E D change in demanded of good 1 change in the price of good 2 Substitutes positive elasticity of hot dogs eat more hamburgers Complements negative elasticity of computers buy less software Supply how much quanitity supplied responds to change in price More elastic in the long run Price Elasticity of Supply measures how much the quantity supplied responds to changes in the price P E S change in supplied change in price Use midpoint method E 1 then supply is elastic E approaches horizontal curve Higher the elasticity the flatter the curve E 1 then demand is inelastic E 0 then supply is perfectly inelastic vertical curve E 1 then supply has unit elasticity total revenue remains constant when price changes Depends on the flexibility of sellers to change the amount they produce Elastic quantity supplied responds substantially to change in the price Inelastic quantity supplied responds slightly to change in the price OPEC raised the world price of oil to increase their incomes and reduced the amount supplied The price of oil rose by more then 50 percent Long run producers of oil outside of OPEC respond to high prices by increasing oil exploration and building new extraction capacity Consumers respond with greater conservation Drugs when the government interdicts drug use it raises drug prices and reduces the amount of drugs supplied Demand for drugs inelastic supply curve goes left demand curve stays the same equilibrium price of drugs rises equilibrium quantity falls shows that interdiction does reduce drug use Drug related crime costs for drugs increase drug users will steal more crime in Drug education demand shifts to the left equilibrium price quantity fall total rev creases enue falls Chapter 6 Supply Demand and Government Policies Policies that directly control prices Rent control laws dictate a maximum rent that landlords may charge tenants Minimum Wage laws dictate the lowest wage that firms may pay workers Price controls are usually enacted when policymakers believe that the market price of a good or service is unfair to buyers or sellers Policymakers use taxes to raise revenue for public purposes and to influence market outcomes Price Ceiling a legal maximum on the price at which a good can be sold Price Floor a legal minimum on the price at which a good can be sold If the price ceiling is ABOVE the equilibrium it is NOT BINDING If the price ceiling is BELOW the equilibrium it is a BINDING CONSTRAINT however once market price hits its ceiling it can be raised no further therefore market price price ceiling Price Ceiling has no affect on price or quantity sold If quantity demanded exceeds quantity supplied there is a SHORTAGE If a shortage develops due to a price ceiling a mechanism for rationing will naturally develop Ex long lines for buyers ice cream rationed based on personal bias for sellers When the government imposes a binding price ceiling on a competitive market a shortage of the good arises and sellers must ration the scarce goods among the large number of potential buyers Mechanisms that develop under price ceilings are rarely desirable If the price floor is BELOW the equilibrium it is NOT BINDING If the price floor is ABOVE the equilibrium it is a BINDING CONSTRAIN Market price Price floor A binding price floor causes a SURPLUS Surpluses from binding price floors can lead to undesirable rationing mechanisms Price controls often aimed at helping the poor Ex Minimum wage rent control laws Price controls can sometimes hurt those they are aiming to help Ex Rent control laws give landlords less incentive to maintain buildings There are alternatives for helping those in need of assistance Ex Gov t can pay for a fraction of rent to make housing more affordable for poor fami lies At the same time alternatives cost the government money which raises taxes Taxes raise revenue for public projects such as roads schools and national defense Tax Incidence the manner in which the burden of a tax is shared among participants in a market TAX ON SELLERS EXAMPLE Gov t taxes sellers of ice cream 0 50 to help pay for an event Immediate impact is on the sellers Tax is not levied on buyers and quantity of ice cream demanded at any given price is the same Demand curve does not change The tax on sellers makes the ice cream less profitable at any given price Supply curve shifts Tax increases the cost of producing and selling which results in a shift of the supply curve to the left and up Sellers now make 0 50 less per cone which results in them increasing price by 0 50 Sellers send the entire tax to the gov t however buyers and sellers SHARE the burden Taxes discourage market activity When a good is taxed the quantity of the good sold is smaller in the new equilibrium Buyers and sellers share the burden of taxes In the new equilibrium buyers pay more for the good and sellers receive less TAX ON BUYERS EXAMPLE Gov t taxes buyers 0 50 per ice cream cone to pay for an event Initial impact is on demand Supply curve is not affected Buyers now pay a tax to
View Full Document
Unlocking...