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20 - 1 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight.

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Presentation on theme: "20 - 1 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight."— Presentation transcript:

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2 20 - 1 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Elasticity of Supply & Demand

3 20 - 2 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization HOW MUCH MORE OR LESS? THE LAW OF DEMAND SAYS... PRICE ELASTICITY OF DEMAND Consumers will buy more when prices go down and less when prices go up Price Elasticity Provides an Answer

4 20 - 3 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The percentage change in price The percentage change in quantity.10.20 Elasticity is.5 Q P P1P1 P2P2 Q1Q1 Q2Q2 D Measures Responsiveness to Price Changes PRICE ELASTICITY OF DEMAND

5 20 - 4 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The percentage change in price The percentage change in quantity Q P P1P1 P2P2 Q1Q1 Q2Q2 D Commonly Expressed as… PRICE ELASTICITY OF DEMAND %P % Q d Elasticity is.5

6 20 - 5 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The Price-Elasticity Coefficient and Formula PRICE ELASTICITY OF DEMAND E d = Percentage change in quantity demanded of product X Percentage change in price of product X Or equivalently… E d = Change in quantity demanded of X Original quantity demanded of X Change in price of X Original price of X Elimination of the Minus Sign

7 20 - 6 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Inelastic 0 < X < 1 Typical of necessities one must have Typical of luxuries one wants Elastic from 1 < X < Unit elastic when exactly = 1 Quantity change offsets Price change Price Elasticity is... PRICE ELASTICITY OF DEMAND

8 20 - 7 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Interpretations of E d PRICE ELASTICITY OF DEMAND Elastic Demand E d =.04.02 = 2 Inelastic Demand E d =.01.02 =.5 Unit Elasticity E d =.02 = 1

9 20 - 8 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Extreme Cases PRICE ELASTICITY OF DEMAND Perfectly Inelastic Demand Perfectly Elastic Demand P 0 P 0 D1D1 E d = 0 D2D2 E d = Q Q

10 20 - 9 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization DETERMINANTS OF PRICE ELASTICITY OF DEMAND Substitutability Proportion of Income Luxuries versus Necessities Time

11 20 - 10 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization More Accurate Calculation – The Midpoint Formula PRICE ELASTICITY OF DEMAND EdEd = Change in quantity Sum of Quantities/2 Change in price Sum of prices/2 EdEd = ΔQΔQ AVG Q ΔPΔP AVG P

12 20 - 11 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Lemonade Stand You sell 24 glasses for $.50 each. P x Q = Total Revenue (TR) $.50 x 24 = $12 = Total Revenue -$4 = Total Cost $8 = Profit

13 20 - 12 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Total Revenue Total Revenue (TR): The total dollars received by a firm for selling a product. AKA Consumer Expenditures

14 20 - 13 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization CIRCULAR FLOW MODEL BUSINESSES HOUSEHOLDS RESOURCE MARKET RESOURCESINPUTS $ COSTS$ INCOMES PRODUCT MARKET GOODS & SERVICES GOODS & SERVICES $ CONSUMPTION$ REVENUE

15 20 - 14 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Q P D When prices are low, TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE So is total revenue

16 20 - 15 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Q P D Total revenue rises with price to a point... TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

17 20 - 16 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Q P D Total revenue rises with price to a point... then declines TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

18 20 - 17 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Q P D Total revenue rises with price to a point... then declines TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

19 20 - 18 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Q P D Total revenue rises with price to a point... then declines TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

20 20 - 19 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Q P D Total revenue rises with price to a point... then declines Inelastic Demand Inelastic Demand TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE

21 20 - 20 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Q P D Total revenue rises with price to a point... then declines Elastic Demand Elastic Demand Inelastic Demand TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE Inelastic Demand

22 20 - 21 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Q P D Total revenue rises with price to a point... then declines Elastic Demand Elastic Demand Inelastic Demand TR Quantity Demanded PRICE ELASTICITY & TOTAL REVENUE Inelastic Demand Unit Elastic

23 20 - 22 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL REVENUE TEST Another way to determine elasticity P x Q = TR P and Q move opposite each other So how do we know what happens to TR? –If P and TR move together demand is inelastic –If Q and TR move together demand is elastic –If TR doesnt move demand is unit elastic

24 20 - 23 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Other Elasticities

25 20 - 24 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization PRICE ELASTICITY OF SUPPLY Es=Es= %ΔQS%ΔQS %ΔP%ΔP

26 20 - 25 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization PoPo P Q D1D1 QoQo An increase in demand without enough time to change supply causes… SmSm Immediate Market period PRICE ELASTICITY OF SUPPLY

27 20 - 26 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization PoPo PmPm P Q D1D1 QoQo D2D2 An increase in demand without enough time to change supply causes… an increase in price SmSm Immediate Market period PRICE ELASTICITY OF SUPPLY

28 20 - 27 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization PoPo P Q D1D1 QoQo Short Run PRICE ELASTICITY OF SUPPLY An increase in demand with more elastic supply causes... SsSs

29 20 - 28 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization PoPo P Q D1D1 QoQo D2D2 Short Run PRICE ELASTICITY OF SUPPLY PsPs An increase in demand with more elastic supply causes... a smaller increase in price SsSs QsQs

30 20 - 29 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization PoPo P Q D1D1 QoQo Long Run PRICE ELASTICITY OF SUPPLY An increase in demand in the long run allows greater change causing... SLSL

31 20 - 30 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization PoPo P Q D1D1 QoQo D2D2 Long Run PRICE ELASTICITY OF SUPPLY PLPL An increase in demand in the long run allows greater change causing... SLSL QLQL Even more elastic response - less price increase

32 20 - 31 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization CROSS PRICE ELASTICITY OF DEMAND E xy = %ΔQ DX %ΔPY%ΔPY Positive Sign Goods are Substitutes Negative Sign Goods are Complementary Zero or Near-Zero Value Goods are Unrelated

33 20 - 32 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization INCOME ELASTICITY OF DEMAND E i = %ΔQD%ΔQD %Δ Income Positive Sign Goods are Normal or Superior Negative Sign Goods are Inferior

34 20 - 33 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Price Controls

35 20 - 34 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization PRICE CONTROLS Enacted when policymakers believe the market price is unfair to buyers or sellers.

36 20 - 35 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization CONTROLS ON PRICES 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.

37 20 - 36 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How Price Ceilings Affect Market Outcomes Two possibilities: –Not binding (not effective) –Binding (effective)

38 20 - 37 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization A Market with a Price Ceiling (a) A Price Ceiling That Is Not Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium quantity $4 Price ceiling Equilibrium price Demand Supply 3 100

39 20 - 38 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization A Market with a Price Ceiling (b) A Price Ceiling That Is Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply 2Price ceiling Shortage 75 Quantity supplied 125 Quantity demanded Equilibrium price $3

40 20 - 39 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How Price Ceilings Affect Market Outcomes A binding price ceiling creates –A shortage because Q D > Q S. –Non-price rationing Long lines Discrimination

41 20 - 40 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization CASE STUDY: Lines at the Gas Pump In the early 1970s the government placed a price ceiling on gas. In 1973, OPEC raised the price of crude oil (input for gas).

42 20 - 41 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The Market for Gasoline with a Price Ceiling (a) The Price Ceiling on Gasoline Is Not Binding Quantity of Gasoline 0 Price of Gasoline 1. Initially, the price ceiling is not binding... Price ceiling Demand Supply,S1S1 P1P1 Q1Q1

43 20 - 42 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The Market for Gasoline with a Price Ceiling (b) The Price Ceiling on Gasoline Is Binding Quantity of Gasoline 0 Price of Gasoline Demand S1S1 S2S2 Price ceiling QSQS 4.... resulting in a shortage. 3.... the price ceiling becomes binding... 2.... but when supply falls... P2P2 QDQD P1P1 Q1Q1

44 20 - 43 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Rent Control

45 20 - 44 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How Price Floors Affect Market Outcomes Two possibilities: –Not binding –Binding

46 20 - 45 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization A Market with a Price Floor (a) A Price Floor That Is Not Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Equilibrium quantity 2 Price floor Equilibrium price Demand Supply $3 100

47 20 - 46 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization A Market with a Price Floor (b) A Price Floor That Is Binding Quantity of Ice-Cream Cones 0 Price of Ice-Cream Cone Demand Supply $4 Price floor 80 Quantity demanded 120 Quantity supplied Equilibrium price Surplus 3

48 20 - 47 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How Price Floors Affect Market Outcomes A binding price floor causes... – A surplus because Q S > Q D. – Non-price rationing

49 20 - 48 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Minimum wage laws dictate the lowest price possible for labor that any employer may pay. CASE STUDY: MINIMUM WAGE

50 20 - 49 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How the Minimum Wage Affects the Labor Market Quantity of Labor Wage 0 Labor demand Labor Supply Equilibrium employment Equilibrium wage

51 20 - 50 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How the Minimum Wage Affects the Labor Market Quantity of Labor Wage 0 Labor Supply Labor surplus (unemployment) Labor demand Minimum wage Quantity demanded Quantity supplied

52 20 - 51 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How Price Controls Affect Total Surplus A F B D C E Quantity 0 Price Demand Supply PFPF Q2Q2 PCPC Price Floor Price Ceiling P1P1 Q1Q1 Price

53 20 - 52 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Price Controls on Drugs

54 20 - 53 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Taxation & Deadweight Loss

55 20 - 54 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Application: The Costs of Taxation Review Buyers and sellers receive benefits from taking part in the market. The equilibrium in a market maximizes the total welfare of buyers and sellers.

56 20 - 55 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization THE DEADWEIGHT LOSS OF TAXATION When a tax is levied on a good –Price paid by buyers rises –Price received by sellers falls

57 20 - 56 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The Effects of a Tax Size of tax Quantity 0 Price Price buyers pay Price sellers receive Demand Supply Price without tax Quantity without tax Quantity with tax

58 20 - 57 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How a Tax Affects Market Participants A tax places a wedge between the price buyers pay and sellers receive. The quantity sold falls below the pre-tax equilibrium.

59 20 - 58 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How a Tax Affects Market Participants Tax Revenue T = the size of the tax Q = the quantity of the good sold T Q = Tax Revenue

60 20 - 59 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Tax Revenue Tax revenue (T × Q) Size of tax (T ) Quantity sold (Q) Quantity 0 Price Demand Supply Quantity without tax Quantity with tax Price buyers pay Price sellers receive

61 20 - 60 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How a Tax Affects Market Participants Changes in Welfare –Deadweight loss is the fall in total surplus.

62 20 - 61 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How a Tax Affects Welfare A F B D C E Quantity 0 Price Demand Supply = PBPB Q2Q2 = PSPS Price buyers pay Price sellers receive = P1P1 Q1Q1 Price without tax

63 20 - 62 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization DETERMINANTS OF DEADWEIGHT LOSS What determines whether the deadweight loss from a tax is large or small? –Elasticities of Demand & Supply –More elastic curves bring more loss

64 20 - 63 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Tax Incidence Who pays for the tax? The more inelastic curve pays more

65 20 - 64 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Tax Distortions and Elasticities Price 0Quantity Demand Supply Size of tax

66 20 - 65 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Tax Distortions and Elasticities Price 0 Quantity Demand Supply Size of tax

67 20 - 66 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Tax Distortions and Elasticities Demand Supply Price 0 Quantity Size of tax

68 20 - 67 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Tax Distortions and Elasticities Price 0 Quantity Size of tax Demand Supply

69 20 - 68 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization How a Tax Affects Market Participants The combined welfare losses to buyers and sellers exceed the revenue raised by the government.

70 20 - 69 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The Effects of a Tariff A tariff is a tax on goods produced abroad and sold domestically. Tariffs raise the price of imported goods by the amount of the tariff.

71 20 - 70 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The Effects of a Tariff Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price with tariff Tariff Imports without tariff Equilibrium without trade Price without tariff World price Imports with tariff Q S Q S Q D Q D

72 20 - 71 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The Effects of a Tariff Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Imports without tariff Equilibrium without trade Price without tariff World price Q S Q D Producer surplus before tariff Consumer surplus before tariff

73 20 - 72 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The Effects of a Tariff E Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price with tariff Tariff Imports without tariff Price without tariff World price Q S Imports with tariff Q S Q D Q D Tariff Revenue

74 20 - 73 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization The Effects of a Tariff C G A EDF B Price of Steel 0 Quantity of Steel Domestic supply Domestic demand Price with tariff Tariff Imports without tariff Price without tariff World price Imports with tariff Q S Q S Q D Q D Deadweight Loss

75 20 - 74 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Consumer Behavior & Utility Maximization

76 20 - 75 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization LAW OF DIMINISHING MARGINAL UTILITY Utility Subjective Difficult to Quantify Total Utility Marginal Utility graphically examined...

77 20 - 76 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 0101 0 10 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

78 20 - 77 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 0101 0 10 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

79 20 - 78 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 012012 0 10 18 10 8 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

80 20 - 79 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 01230123 0 10 18 24 10 8 6 0 1 2 3 4 5 6 7 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 1 2 3 4 5 6 7

81 20 - 80 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 0123401234 0 10 18 24 28 10 8 6 4 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

82 20 - 81 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 012345012345 0 10 18 24 28 30 10 8 6 4 2 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

83 20 - 82 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 01234560123456 0 10 18 24 28 30 10 8 6 4 2 0 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

84 20 - 83 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 0123456701234567 0 10 18 24 28 30 28 10 8 6 4 2 0 -2 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 TU MU 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7

85 20 - 84 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization TOTAL AND MARGINAL UTILITY Tacos consumed per meal Total Utility, Utils Marginal Utility, Utils 0123456701234567 0 10 18 24 28 30 28 10 8 6 4 2 0 -2 Units consumed per meal 30 20 10 Total Utility (utils) Marginal Utility (utils) 10 8 6 4 2 0 -2 TU MU 0 1 2 3 4 5 6 7 1 2 3 4 5 6 7 Observe Diminishing Marginal Utility

86 20 - 85 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization THEORY OF CONSUMER BEHAVIOR Utility Maximizing Rule The consumers income should be allocated so that the last dollar spent on each product yields the same amount of marginal utility. Illustrated...

87 20 - 86 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 $ 10 income UTILITY MAXIMIZING COMBINATION How should the $10 income be allocated? Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

88 20 - 87 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 $ 10 income UTILITY MAXIMIZING COMBINATION Examine the two marginal utilities Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

89 20 - 88 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 $ 10 income UTILITY MAXIMIZING COMBINATION Examine the two marginal utilities …per dollar Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

90 20 - 89 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 $ 10 income UTILITY MAXIMIZING COMBINATION Decision: Buy 1 Product B for $2 Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

91 20 - 90 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 $ 10 income UTILITY MAXIMIZING COMBINATION What next? Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

92 20 - 91 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 $ 10 income UTILITY MAXIMIZING COMBINATION What next? Buy one of each Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

93 20 - 92 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 $ 10 income UTILITY MAXIMIZING COMBINATION and then... ($5 left) Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

94 20 - 93 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 $ 10 income UTILITY MAXIMIZING COMBINATION third unit of product B Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

95 20 - 94 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 $ 10 income UTILITY MAXIMIZING COMBINATION $3 left... Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

96 20 - 95 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 $ 10 income UTILITY MAXIMIZING COMBINATION $3 left... Buy both! Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

97 20 - 96 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization First 10 10 24 12 Second 8 8 20 10 Third 7 7 18 9 Fourth 6 6 16 8 Fifth 5 5 12 6 Sixth 4 4 6 3 Seventh 3 3 4 2 $ 10 income UTILITY MAXIMIZING COMBINATION Income is gone... the last dollar spent on each good gave the same utility (8) per dollar Unit of product Product A: Price = $1 Product B: Price = $2 Marginal utility, utils Marginal utility per dollar (MU/price) Marginal utility, utils Marginal utility per dollar (MU/price)

98 20 - 97 Price Elasticity of Demand Determinants of Price Elasticity Price Elasticity and Total Revenue Other Elasticities Price Controls Taxation & Deadweight Loss Consumer Utility Maximization Algebraic Restatement of the Utility Maximization Rule MU of A Price of A MU of B Price of B = Consumption Bundles 8 Utils $1 16 Utils $2 =


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