1. ii.) Price controls and government policies effect on the market
Lecture Three
i.) Elasticity
ii.) Price controls and government policies effect on the market
Professor Chris Wimmer
Oct

2. Elasticity
Elasticity measures the responsiveness of demand or supply to one of its determinants or factors
We need this tool to help us find new equilibrium price and quantity when a shift or movement occurs

3. Price elasticity of demand
This measure of how much quantity demanded changes with a change in price
Price elasticity of demand = % Δ quantity demanded / % Δ price
= Q2-Q1/Q1 x 100 / P2-P1/P1 x 100
Let’s do some examples

4. Elasticity factors
Close substitutes – Products with close substitutes will have very elastic demands
Necessities - Necessities will have inelastic demands vs. luxuries
Market definition – more narrow defined markets have more elastic demand e.g. Porsche vs. cars
Time horizon – Longer time horizons have more elastic demand – this is because of time to change

5. Midpoint method
Sometimes calculating elasticity on a curve gives different answers depending what direction you go on the line
Midpoint formula eliminates this problem see pg. 92
Not all demand curves have constant elasticity. Straight lines do not!

6. Types of demand curves Elastic – elasticity is greater than one
These curves are usually a little flat
Unit Elastic – elasticity = 1
Inelastic – elasticity is less than one
These curves are usually steep
Lets draw them

7. Revenue
Revenue is the amount of money a firm makes before subtracting costs
You can calculate it by P x Q
Changes in price change the revenue depending on the elasticity of demand

8. Elasticity and revenue
If the demand is elastic then price and revenue move in opposite directions
If the demand is inelastic then price and revenue move in the same direction
If the demand is unit elastic then revenue stays constant as price changes
These are generalizations but typically true

9. Other demand elasticities
Income elasticity of demand – change in quantity demanded as income changes
I E D = % Δ quantity demanded / % Δ income
Cross-price elasticity of demand (CPED) – change in the quantity of product 1 from a change in the price of product 2
C P E D - % Δ quantity demanded of product 1 / % Δ price of product 2
Compliments are – ve CPED, substitutes are + ve CPED

10. Elasticity of Supply
This measures how the supply of a good changes as prices changes
Price elasticity of supply = %Δ quantity supplied / % Δ price Or
= Qs2 – Qs1/Qs1 x 100 / P2-P1/P1 x 100
Let’s try calculating elasticity of supply

11. Elasticity and supply curves
Let’s draw an elastic supply curve, an inelastic supply curve, and a unit elastic supply curve

12. Revenue, demand and supply
Let’s work on some examples of shifts in supply, demand, supply and demand to see what happens to revenue under different situations

13. Farmer’s Crops
Is a large harvest a good thing if it is only for one farmer? What about for all farmers?

14. ii.) Price controls and government policies effect on the market
When the market functions properly it always provides the most efficient allocation of goods
But it does not always provide the most equitable (equal) allocation between citizens
This is when sometimes the government is needed

15. Price ceilings
If the government feels that prices are too high, they can impose a price ceiling
A price ceiling is binding if it is below the market price
A price ceiling is not binding if it is above market price

16. See pg. 115

17. Price floors
In other situations, the government may help a particular product or industry by setting a price floor
Trade sometimes will make this choice a bad one. Why?

19. Taxes
The government mostly taxes to raise income for the country so they can spend money where needed
Sometimes taxes are used as an incentive
What goods are the best for the government to tax, elastic or inelastic demands?

20. Tax incidence
Tax incidence refers to how much of the tax is paid by buyers and how much is paid by sellers

21. If we tax the buyers
If buyers are taxed they will buy less of a product because they are paying a higher price even if to two different places.
The sellers and buyers will end up sharing the tax burden

23. What if the sellers are taxed
Much like if the buyers are taxed the sellers are receiving less of the profit from the sale price because they have to include the tax
Thus we see by both graphs that a tax on sellers or buyers has the same effect

25. Elasticity and taxes
The burden of the tax will be paid by the person with a less elastic curve
The elasticity can be seen as the likelihood of the buyer or seller to exit the market

28. Homework
Pg. 132  134
Q# 2, 3, 4, 5, 6, 7
Pr# 1, 2, 3, 4, 6, 7, 8, 10, 11