Review from Test 2 Friday December 5 2014 10 14 AM Elasticity Elasticity of Demand the measure of how responsive quantity demanded is to the price of the good It is measured by taking the percentage change in the quantity demanded and dividing it by the percentage change in price Elastic measure of elasticity demand in absolute value 1 Inelastic measure of elasticity demand in absolute value 1 Elasticity of Supply the measure of how responsive quantity supplied is to the price of the good It is measured by taking the percentage change in the quantity supply and dividing it by the percentage change in price When demand is inelastic and price rises revenues also rise When demand is elastic and prices rise revenues decrease Income Elasticity measures the responsiveness of quantity demanded to changes in income It is calculated as the percentage change in quantity demanded divided by the percentage change in income Cross Price Elasticity measures the responsiveness of the quantity demanded of good x to changes in the price of good y It is calculates as the percentage change in quantity demanded of X divided by the percentage change in price of Y Elasticity Check If true Otherwise Of Demand Ed 1 Elastic Es 1 Ei 0 Elastic Normal Inelastic Inelastic Inferior Ex y 0 Substitute Complement Of Supply Of Income Cross Price Tax and Subsidies Tax Incidences how much of the burden of the tax falls on consumers Calculated by taking the change in the total price paid by consumers due to the tax and dividing it by the tax It is always a number between 0 no burden on consumers and 1 the entire tax is pass on to consumers Pc Ps Tax If supply is horizontal then the supply is perfectly elastic o No producer surplus price suppliers receive is the supply curve o Tax incidence is 1 Inelastic pays the taxes If supply is vertical then the supply is perfectly inelastic o No Dead Weight Loss equilibrium does not change o Tax incidence is 0 Consumer Surplus Producer Surplus Total Revenue and DWL with Taxes With a tax of 15 Subsidies the negative tax the actual incidence will be determined by the elasticity of supply and elasticity of demand however the relationship between the suppliers price and the consumers price is reversed to that of a tax Ps Pc Subsidy Right side of the equilibrium Perfectly Elastic Demand Consumer Surplus o When the demand is horizontal o No consumer surplus the demand curve still overlaps the price Perfectly Inelastic Demand o When the demand is vertical o No dead weight loss the quantity does not change as a result of a subsidy Producer Surplus Cost of the Subsidy Dead Weight Loss Externalities Externalities a cost or benefit that is incurred as a result of a market transaction by someone who is not involved in the market transaction Marginal Social Benefit the sum of the private benefits from the transaction The individual consumers willingness to pay and the external benefits costs incurred by others Marginal Social Cost the sum of the private costs of production The supply curve and the external costs benefits incurred by others Positive Consumption Externality when MSB Private Benefits MSB is above the demand curve Dead Weight Loss Negative Consumption Externality when MSB Private Benefits MSB is below the demand curve Dead Weight Loss Positive Production Externality MSC Private Costs MSC below the supply curve Dead Weight Loss Negative Production Externality MSC Private Costs MSC is above the supply curve Dead Weight Loss Pigouvian Tax or Subsidy Tax to correct negative externalities Subsidy to correct positive externalities The size of the tax or subsidy must be sufficient to induce efficient behavior therefore equaling the size of the externality at the efficient quantity Property Rights to Internalize Externality An attempt to make the external benefits or costs tradable The Coase Theorem When property rights are well defined and transactions costs are low i e it is easy to negotiate then regardless of who is assigned the property right the private parties can reach the efficient outcome through negotiation Rival if one person s consumption of the good prevents or detracts from another s consumption of the good Excludable it is possible to prevent one person from enjoying its benefits Public Goods under produced in the market place due to the lack of excludability Usually provided by the government to correct for lack of this problem Common Resources usually over used in the market due to the lack of excludability Usually is heavily regulated to correct for this Conversion to private property might also be used to correct for this problem Consumers Choice Bundle a bundle refers to a combination of goods 1 All bundles can be compared 2 More is better 3 Transitivity 4 Averages are weakly better than extremes Indifference Curves a graphical representation of all bundles that a consumer is indifferent between 1 There are an infinite amount of them 2 If bundle X is on an indifference curve that is higher than the indifference curve that bundle Y is on then X is preferred to Y Indifference curves cannot cross 3 4 The shape of an indifference curve is weakly bowed away from the origin Marginal Rate of Substitution the amount of the good on the y axis that a consumer would be willing to give up in order to get one unit of the x axis and remain indifferent between the two This is equal to in absolute value to the slope of the indifference curve To Graph 1 How much of good X can you buy with the income given 2 How much of good Y can you buy with the income given