Economics: Exam #25: Elasticity and its Application•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 $•Drop negative signs•P.E.D. (btwn 2 points)=(Q2-Q1)/[(Q2+Q1)/2]÷(P2-P1)/[(P2+P1)]•E>1 then demand is elastic•E approaches ∞ (horizontal curve)•Higher the elasticity, the flatter the curve•E<1 then demand is inelastic•E=0 then demand is perfectly inelastic (vertical curve)•E=1 demand has unit elasticity (total revenue stays constant when price changes)•Total Revenue: amount paid by buyers and received by sellers of a good.•P X Q •Demand is Elastic: increase in price = decrease in total revenue•Demand is Inelastic: inccrease in price = increase in total revenue•Income Elasticity of Demand: measures how the quantity demanded changes as the consumer income changes.•IED=% change in # demanded ÷ % change in income•Normal Goods: higher income = higher demand•Positive income elasticity•Food, clothing•Inferior Goods: higher income = less demand•Negative income elasticity•Bus rides•Cross-Price Elasticity of Demand: measures how quantity demanded of one good responds to change in the price of another good.•C.P.E.D=% change in # demanded of good 1 ÷ % change in the price of good 2•Substitutes: positive elasticity ($ 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 oilexploration 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-creases•Drug education: demand shifts to the left, equilibrium price&quantity fall, total rev-enue fallsChapter 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 marketTAX 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 theleft 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
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