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Elasticity and its Application E conomics P R I N C I P L E S O F N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich 5

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ELASTICITY AND ITS APPLICATION 2 Calculating Percentage Changes So, we instead use the midpoint method: end value – start value midpoint x 100% The midpoint is the number halfway between the start & end values, the average of those values. It doesn’t matter which value you use as the “start” and which as the “end” – you get the same answer either way!

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ELASTICITY AND ITS APPLICATION 3 Calculating Percentage Changes Using the midpoint method, the % change in P equals $250 – $200 $225 x 100% = 22.2% The % change in Q equals 12 – 8 10 x 100% = 40.0% The price elasticity of demand equals 40/22.2 = 1.8

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A C T I V E L E A R N I N G 1 Calculate an elasticity 4 Use the following information to calculate the price elasticity of demand for hotel rooms: if P = $70, Q d = 5000 if P = $90, Q d = 3000

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A C T I V E L E A R N I N G 1 Answers 5 Use midpoint method to calculate % change in Q d (5000 – 3000)/4000 = 50% % change in P ($90 – $70)/$80 = 25% The price elasticity of demand equals 50% 25% = 2.0

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ELASTICITY AND ITS APPLICATION 6 Price Elasticity and Total Revenue If demand is elastic, then price elast. of demand > 1 % change in Q > % change in P The fall in revenue from lower Q is greater than the increase in revenue from higher P, so revenue falls. Revenue = P x Q Price elasticity of demand = Percentage change in Q Percentage change in P

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ELASTICITY AND ITS APPLICATION 7 Price Elasticity and Total Revenue Elastic demand (elasticity = 1.8) P Q D $ If P = $200, Q = 12 and revenue = $2400. When D is elastic, a price increase causes revenue to fall. $250 8 If P = $250, Q = 8 and revenue = $2000. lost revenue due to lower Q increased revenue due to higher P Demand for your websites

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ELASTICITY AND ITS APPLICATION 8 Price Elasticity and Total Revenue Now, demand is inelastic: elasticity = 0.82 P Q D $ If P = $200, Q = 12 and revenue = $2400. $ If P = $250, Q = 10 and revenue = $2500. When D is inelastic, a price increase causes revenue to rise. lost revenue due to lower Q increased revenue due to higher P Demand for your websites

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Supply, Demand, and Government Policies E conomics P R I N C I P L E S O F N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich 6

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A C T I V E L E A R N I N G 1 Price controls Q P S 0 The market for hotel rooms D Determine effects of: A. $90 price ceiling B. $90 price floor C. $120 price floor 10

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A C T I V E L E A R N I N G 1 A. $90 price ceiling Q P S 0 The market for hotel rooms D The price falls to $90. Buyers demand 120 rooms, sellers supply 90, leaving a shortage. shortage = 30 Price ceiling 11

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A C T I V E L E A R N I N G 1 B. $90 price floor Q P S 0 The market for hotel rooms D Eq’m price is above the floor, so floor is not binding. P = $100, Q = 100 rooms. Price floor 12

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A C T I V E L E A R N I N G 1 C. $120 price floor Q P S 0 The market for hotel rooms D The price rises to $120. Buyers demand 60 rooms, sellers supply 120, causing a surplus. surplus = 60 Price floor 13

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A C T I V E L E A R N I N G 2 Effects of a tax Q P S 0 The market for hotel rooms D Suppose govt imposes a tax on buyers of $30 per room. Find new Q, P B, P S, and incidence of tax.

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A C T I V E L E A R N I N G 2 Answers Q P S 0 The market for hotel rooms D Q = 80 P B = $110 P S = $80 Incidence buyers: $10 sellers: $20 Tax P B = P S =

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Consumers, Producers, and the Efficiency of Markets E conomics P R I N C I P L E S O F N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich 7

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17 P Q demand curve A. Find marginal buyer’s WTP at Q = 10. B. Find CS for P = $30. Suppose P falls to $20. How much will CS increase due to… C. buyers entering the market D. existing buyers paying lower price $ A C T I V E L E A R N I N G 1 Consumer surplus

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A C T I V E L E A R N I N G 1 Answers 18 P $ Q demand curve A. At Q = 10, marginal buyer’s WTP is $30. B. CS = ½ x 10 x $10 = $50 P falls to $20. C. CS for the additional buyers = ½ x 10 x $10 = $50 D. Increase in CS on initial 10 units = 10 x $10 = $100

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P Q supply curve A. Find marginal seller’s cost at Q = 10. B. Find total PS for P = $20. Suppose P rises to $30. Find the increase in PS due to… C. selling 5 additional units D. getting a higher price on the initial 10 units 19 A C T I V E L E A R N I N G 2 Producer surplus

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A C T I V E L E A R N I N G 2 Answers P Q supply curve A. At Q = 10, marginal cost = $20 B. PS = ½ x 10 x $20 = $100 P rises to $30. C. PS on additional units = ½ x 5 x $10 = $25 D. Increase in PS on initial 10 units = 10 x $10 = $100 20

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Application: The Costs of Taxation E conomics P R I N C I P L E S O F N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich 8

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A C T I V E L E A R N I N G 1 Answers to A 22 D S CS = ½ x $200 x 100 = $10,000 P Q $ Total surplus = $10,000 + $10,000 = $20,000 PS = ½ x $200 x 100 = $10,000 P = The market for airplane tickets

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A C T I V E L E A R N I N G 1 Answers to B 23 D S CS = ½ x $150 x 75 = $5,625 P Q $ Total surplus = $18,750 PS = $5,625 Tax revenue = $100 x 75 = $7,500 DWL = $1,250 P S = P B = A $100 tax on airplane tickets

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Application: International Trade E conomics P R I N C I P L E S O F N. Gregory Mankiw Premium PowerPoint Slides by Ron Cronovich 9

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A C T I V E L E A R N I N G 1 Analysis of trade 25 Without trade, P D = $3000, Q = 400 In world markets, P W = $1500 Under free trade, how many TVs will the country import or export? Identify CS, PS, and total surplus without trade, and with trade. P Q D S $ $ Plasma TVs

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A C T I V E L E A R N I N G 1 Answers 26 Under free trade, domestic consumers demand 600 domestic producers supply 200 imports = 400 P Q D S $ $ Plasma TVs imports

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A C T I V E L E A R N I N G 1 Answers 27 Without trade, CS = A PS = B + C Total surplus = A + B + C With trade, CS = A + B + D PS = C Total surplus = A + B + C + D P Q D S $1500 $3000 Plasma TVs A B D C gains from trade imports

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