1. Working with Supply and Demand © 2003 South-Western/Thomson Learning

2. Government Intervention in Markets Price CeilingsPrice Ceilings Price FloorsPrice Floors TaxesTaxes

3. Government Intervention in Markets Price Ceiling A government-imposed maximum price in a market

4. Price Ceiling aa a Number of Bottles of Maple Syrup Price per Bottle 6,0005,0004,000 D S $4.00 3.00 2.00 E T R V

5. Government Intervention in Markets When quantity supplied and quantity demanded differ, whichever of the two quantities is smaller, the short side of the market will prevail.

6. Government Intervention in Markets A price ceiling creates a shortage, increasing the time and trouble required to buy the good.A price ceiling creates a shortage, increasing the time and trouble required to buy the good. While the price decreases, the opportunity cost may rise.While the price decreases, the opportunity cost may rise.

7. Government Intervention in Markets Price Floor A government-imposed minimum price in a market

8. Price Floor aaa a Millions of Pounds Price per Pound 200180220 $0.90 0.80 S D J A K

9. Government Intervention in Markets Price floor creates an excess supply of a goodPrice floor creates an excess supply of a good To maintain a price floor, government must prevent excess supply from driving down the market priceTo maintain a price floor, government must prevent excess supply from driving down the market price In practice, government often does this by purchasing the excess supply itselfIn practice, government often does this by purchasing the excess supply itself

10. Government Intervention in Markets Excise Tax A tax on a specific good or service.

11. Excise Tax aaa a Quantity Price per Unit 60120 $1.50.90 S B A

12. Excise Tax An excise tax shifts the market supply curve upward by the amount of the tax. For each quantity supplied, the new, higher supply curve tells us firms’ gross price, and the original, lower supply curve tells us the net price.

13. Excise Tax aa a Tickets (Millions per Year) Price per Ticket 1011.3 $800 700 730 S S' D B A

14. Excise Tax An Excise tax on a good increases the price paid by consumers, but decreases the (net) price received by sellers.An Excise tax on a good increases the price paid by consumers, but decreases the (net) price received by sellers. Both buyers and sellers bear part of the burden of paying taxes.Both buyers and sellers bear part of the burden of paying taxes.

15. Price Elasticity of Demand Calculating Price Elasticity of DemandCalculating Price Elasticity of Demand Elasticity and Straight-line Demand CurvesElasticity and Straight-line Demand Curves Elasticity and Total ExpenditureElasticity and Total Expenditure Categorizing Goods by ElasticityCategorizing Goods by Elasticity Determinants of ElasticityDeterminants of Elasticity Using Price Elasticity of DemandUsing Price Elasticity of Demand

16. Price Elasticity of Demand The sensitivity of quantity demanded to priceThe sensitivity of quantity demanded to price The percentage change in quantity demanded caused by a 1 percent change in priceThe percentage change in quantity demanded caused by a 1 percent change in price

17. Price Elasticity of Demand A percentage change is usually defined as the change in a variable divided by the starting, or base, valueA percentage change is usually defined as the change in a variable divided by the starting, or base, value The base value is always midway between the initial value and the new valueThe base value is always midway between the initial value and the new value

18. Price Elasticity of Demand aa a a Quantity of Laptops C Price per Laptop 100,000200,000300,000400,000500,000600,000 $3,500 3,000 2,500 2,000 1,500 1,000 B A D D

19. Elasticity and Straight-Line Demand Curves Elasticity of demand varies along a straight-line demand curve.Elasticity of demand varies along a straight-line demand curve. More specifically, demand becomes more elastic as we move upward and leftward.More specifically, demand becomes more elastic as we move upward and leftward.

20. Elasticity and Straight-Line Demand Curves aa a Quantity Price... and since equal quantity decreases (horizontal arrows) are larger and larger percentage decreases... Since equal dollar increases (vertical arrows) are smaller and smaller percentage increases... D 1 2 3... demand becomes more and more elastic as we move leftward and upward along a straight line demand curve.

21. Inelastic Demand A price elasticity of demand between 0 and -1

22. Perfectly Inelastic Demand A price elasticity of demand equal to 0

23. Perfectly Elastic Demand Elastic Demand A price elasticity of demand less than -1

24. Extreme Cases of Demand

25. Perfectly Elastic Demand Perfectly (Infinitely) Elastic Demand A price elasticity of demand approaching minus infinity

26. Unitary Elastic Demand A price elasticity of demand equal to -1

27. Elasticity and Total Expenditure If demand is price inelastic, then total expenditure moves in the same direction as price. If demand is price inelastic, then total expenditure moves in the same direction as price. If demand is elastic, total spending moves in the opposite direction from price. If demand is elastic, total spending moves in the opposite direction from price. If demand is unitary elastic, total expenditure remains the same as price changes. If demand is unitary elastic, total expenditure remains the same as price changes.

28. Effects of Price Changes on Expenditure Where Demand is:A price increase will:A price decrease will: inelastic (|E D | < 1)increase expendituredecrease expenditure unitary elastic (|E D | = 1)cause no change incause no change in expenditure elastic (|E D | > 1)decrease expenditureincrease expenditure

29. Effects of Price Changes on Expenditure At any point on a demand curve, buyers’ total expenditures is the area of a rectangle with width equal to quantity demanded and height equal to price.

30. Elasticity and Total Expenditure a a a Quantity of Laptops Price per Laptop 100,000200,000300,000400,000500,000600,000 $3,500 3,000 2,500 2,000 1,500 1,000 500 D B A

31. Determinants of Elasticity Short-run Elasticity An elasticity measured just a short time after a price change

32. Determinants of Elasticity Specific BrandsNarrow CategoriesBroad Categories Tide Detergent–2.79Transatlantic Air Travel –1.30Recreation–1.09 Tourism in Thailand –1.20 Pepsi –2.08Ground Beef –1.02Clothing –0.89 Coke –1.71Pork –0.78Food –0.67 Milk –0.54Imports –0.58 Cigarettes –0.45Transportation –0.56 Electricity –0.40 to –0.50 Beer –0.26 Eggs –0.26 Gasoline –0.20 Oil –0.15

33. Long-run Elasticity An elasticity measured a year or more after a price change

34. Short-run and Long-run Elasticity Short Run (a few months of less)Long Run (a year or more) Use public transit more oftenBuy a more fuel-efficient car Arrange a car poolMove closer to your job Get a tune-upSwitch to a job closer to home Drive more slowly on the highwayMove to a city where less driving is required Eliminate unnecessary trips (use mail order and the Internet instead of driving to stores; locate goods by phone instead of driving around; shop for food less often and buy more each time) It there are two cars, use the more fuel-efficient one

35. Short-run and Long-run Elasticity Easier to find substitutes for an item in the long run than in the short runEasier to find substitutes for an item in the long run than in the short run Thus, demand is more elastic in the long run than in the short runThus, demand is more elastic in the long run than in the short run The more of their total budgets households spend on an item, the more elastic the demand for that itemThe more of their total budgets households spend on an item, the more elastic the demand for that item

36. Price Elasticity of Demand The more elastic the demand curve, the more of an excise tax paid by sellersThe more elastic the demand curve, the more of an excise tax paid by sellers The more inelastic the demand curve, the more of the tax paid by buyersThe more inelastic the demand curve, the more of the tax paid by buyers

37. Price Elasticity of Demand aa a Tickets (Millions per Year) Price per Ticket 11.3 $830 730 S S' D B A Tickets (Millions per Year) Price per Ticket 7.011.3 $730 S S' D AB (a)(b)

38. Other Demand Elasticities Income Elasticity of DemandIncome Elasticity of Demand Cross-Price Elasticity of DemandCross-Price Elasticity of Demand

39. Income Elasticity of Demand The percentage change demanded caused by a 1-percent change in income

40. Income Elasticity of Demand Economic Necessity A good with an income elasticity of demand between 0 and 1 Economic Luxury A good with an income elasticity of demand greater than 1

41. Cross-Price Elasticity of Demand The percentage change in the the quantity demanded of one good caused by a 1-percent change in the price of another good