1. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Understanding Economics 5th edition by Mark Lovewell

2. Chapter 3 Competitive Dynamics and Government Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

3. Learning Objectives After this chapter, you will be able to: 1. comprehend price elasticity of demand, its relation to other demand elasticities, and its impact on sellers’ revenues 2. understand the price elasticity of supply and the links between production periods and supply 3. identify how price elasticities of demand and supply determine the impact of an excise tax on consumers and producers 4. explain how governments use price controls to override the “invisible hand” of competition Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

4. Elastic and Inelastic Demand (a) Price elasticity of demand shows how responsive consumers are to price changes. elastic demand means % change in quantity demanded is more than % change in price inelastic demand means % change in quantity demanded is less than % change in price unit-elastic demand means % change in quantity demand equals % change in price Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

5. Elastic and Inelastic Demand (b) Figure 3.1 Page 58 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Elastic Demand Curve for Ice Cream Cones 05001000 0.40 0.80 1.20 1.60 2.00 2.40 20% 50% 20% 10% D1D1 D2D2 Quantity Demanded (cones per winter month) Price ($ per cone) Inelastic Demand Curve for Ice cream Cones 0.40 0.80 1.20 1.60 2.00 2.40 05001000 Quantity Demanded (cones per summer month) Price ($ per cone) 1800 2000

6. Perfectly Elastic and Perfectly Inelastic Demand (a) Perfectly elastic demand means a constant price and a horizontal demand curve. Perfectly inelastic demand means a constant quantity demanded and a vertical demand curve. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

7. Perfectly Elastic and Perfectly Inelastic Demand (b) Figure 3.2 Page 59 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Perfectly Elastic Demand Curve for Soybeans 0 1.60 D3D3 Quantity Demanded (tonnes) Price ($ per tonnes) Perfectly Inelastic Demand Curve for Insulin 01000 Quantity Demanded (litres) Price ($ per tonnes) D4D4

8. Total Revenue and the Price Elasticity of Demand (a) A price change causes total revenue to change in the opposite direction when demand is elastic. A price change causes total revenue to change in the same direction when demand is inelastic. A price change does not affect total revenue when demand is unit-elastic. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

9. Revenue Changes with Elastic Demand Figure 3.3 Page 60 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Demand Curve for Videos 1 2 3 4 5 05001000 Quantity Demanded (videos rented each day) Price ($ to rent a video) 1500 A BC D

10. Revenue Changes with Inelastic Demand Figure 3.4 Page 61 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Demand Curve for Amusement Park Rides 1 2 3 4 5 020006000 10 000 E FG D 4000 8000 Quantity Demanded (riders each day) Price ($ per ride)

11. Total Revenue and the Price Elasticity of Demand (b) Figure 3.5 Page 62 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Demand Elasticity and Changes in Total Revenue Elastic Demand Inelastic Demand Unit-Elastic Demand Price Change up down up down up down Change in Total Revenue down up down unchanged

12. Determinants of the Price Elasticity of Demand There are four determinants: portion of consumer incomes (products with smaller portions more inelastic) access to substitutes (products with more substitutes more elastic) necessities versus luxuries (more inelastic for necessities and more elastic for luxuries) time (more elastic with the passage of time) Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

13. Calculating Price Elasticity of Demand A numerical value for price elasticity of demand (e d ) is found by taking the ratio of the changes in quantity demanded and in price, each divided by its average value. In mathematical terms: e d = ΔQ d ÷ average Q d Δprice ÷ average price Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

14. Elasticity and a Linear Demand Curve (a) A linear demand curve has a different price elasticity (e d ) at every point. At high prices, the change in quantity demanded (price) is relatively large (small) relative to average quantity demanded (price), giving a large e d. At low prices, the change in quantity demand (price) is relatively small (large) relative to average quantity demanded, giving a small e d. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

15. Elasticity and a Linear Demand Curve (b) Figure 3.6 Page 64 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. 0 1 23 Quantity Demanded (millions of sodas) Market Demand Curve for Sodas Price ($ per soda) 1 2 3 4 5 Market Demand Schedules for Sodas 5 4 3 2 1 0 0 1 2 3 4 5 9.00 2.33 1.00 0.43 0.11 Price ($ per soda) 4 Price Elasticity of Demand (e d ) Quantity Demanded (millions of sodas) 5 e d > 1 e d = 1 e d < 1

16. Income Elasticity Income elasticity (e i ) is the responsiveness of a product’s quantity demanded to changes in consumer income. In mathematical terms: e i = ΔQ d ÷ average Q d ΔI ÷ average I Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

17. Cross-Price Elasticity Cross-price elasticity (e i ) is the responsiveness of the quantity demanded of one product (x) to a change in price of another (y). In mathematical terms: e xy = ΔQ d ÷ average Q d ΔP y ÷ average P y Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

18. Elastic and Inelastic Supply Price elasticity of supply measures the responsiveness of quantity supplied to price changes. Elastic supply means % change in quantity supplied is more than % change in price. Inelastic supply means % change in quantity supplied is less than % change in price. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

19. Elastic and Inelastic Supply Figure 3.7, Page 67 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Elastic Supply Curve for Tomatoes 0100 000120000 1 2 3 4 S1S1 Quantity Supplied (kilograms per year) Price ($ per kilogram) 0 Inelastic Supply Curve For Tomatoes 100 000120 000 Quantity Supplied (kilograms per year) Price ($ per kilogram) 1 2 3 4 S2S2 50% 100%20%

20. Perfectly Elastic and Perfectly Inelastic Supply Perfectly elastic supply means a constant price and a horizontal supply curve. Perfectly inelastic supply means a constant quantity supplied and a vertical supply curve. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

21. Time and the Price Elasticity of Supply (a) Price elasticity of supply changes over three production periods: Supply is perfectly inelastic in the immediate run. Supply is either elastic or inelastic in the short run. Supply is perfectly elastic for a constant-cost industry and very elastic for an increasing-cost industry in the long run. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

22. Time and the Price Elasticity of Supply (b) Figure 3.8, Page 68 (continued in part (e)) Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Immediate-Run Supply Elasticity for Strawberries 0 S1S1 Quantity Supplied (kilograms per month) Price ($ per kilogram) S2S2 750 0000 Short-Run Supply Elasticity For Strawberries 11 Quantity Supplied (millions of kilograms per year) Price ($ per kilograms) 2.50 2.00 9

23. Time and the Price Elasticity of Supply (c) If strawberries are produced in a constant-cost industry: A higher price of strawberries raises production but not resource prices. As new businesses enter the industry in the long run due to a higher price of strawberries, this price is gradually pushed back down to its original level. Therefore the long-run supply curve for a constant-cost industry is perfectly elastic. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

24. Time and the Price Elasticity of Supply (d) If strawberries are produced in a increasing-cost industry: A higher price of strawberries raises production and also resource prices. As new businesses enter the industry in the long run due to a higher price of strawberries, this price is gradually pushed back down to its lowest possible level, but this level is higher than it was originally. Therefore the long-run supply curve for an increasing- cost industry is very elastic. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

25. Time and the Price Elasticity of Supply (e) Figure 3.8, Page 68 (continued from part (b)) Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Long-Run Supply Elasticity 0 Quantity Supplied (millions of kilograms per decade) Price ($ per kilograms) S3S3 2.00 S4S4 Constant- cost Industry Increasing- cost Industry

26. Calculating Price Elasticity of Supply A numerical value for price elasticity of supply (e s ) is found by taking the ratio of the changes in quantity supplied and in price, each divided by its average value. In mathematical terms: e s = ΔQ s ÷ average Q s Δprice ÷ average price Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

27. Excise Taxes (a) An excise tax is a tax on a particular product expressed as a dollar amount per unit of quantity. Such a tax creates a new supply curve (S 1 ) seen by consumers. It is vertically above the initial supply curve (S 0 ) seen by producers. The reason for this difference is that the price as seen by consumers is now higher than that seen by producers. Copyright © 2000 by McGraw-Hill Ryerson Limited. All rights reserved.

28. Excise Taxes (b) The after-tax price for consumers is found where S 1 crosses the demand curve. The after-tax equilibrium price for producers is the corresponding price on S 0. The total tax paid by consumers is found by multiplying their tax-induced price rise by after-tax quantity. Similarly, the total tax paid by consumers is found by multiplying their corresponding price drop by after-tax quantity. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

29. The Impact of an Excise Tax Figure 3.9, page 71 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. S1S1 a d A B (millions of tonnes) Quantity Supplied Quantity Demanded (D)(S 0 ) 5 7 9 11 13 11 9 7 5 0 S0S0 D Market Demand and Supply Curves For Strawberries Price ($ per tonne) 3.00 2.50 2.00 1.50 1.00 0.50 3.00 2.50 2.00 1.50 1.00 3.50 13579111315 Quantity (millions of kg per year) Price ($ per kg) The Impact of an Excise Tax 4.00 c (S 1 ) 9 7 5 3 1 b $1

30. The Effect of Elasticity For a given supply curve, the more elastic the demand curve the greater the proportion of an excise tax paid by producers. For a given demand curve, the more elastic the supply curve the greater the proportion of an excise tax paid by consumers. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

31. Excise Taxes and Demand Elasticity Figure 3.10, page 72 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. S0S0 D c 2.75 1.75 a d A B 2.25 1.25 A B d a 8 6 2.00 9 Quantity (millions of kg per year) Price ($ per kg) Inelastic Demand Price ($ per kg) 9 Elastic Demand Quantity (millions of kg per year) S0S0 D c S1S1 S1S1 b $1 b

32. Excise Taxes and Supply Elasticity Figure 3.11, page 73 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. 2.00 9 Quantity (millions of kg per year) Price ($ per kg) Inelastic Supply 9 Elastic Supply Quantity (millions of kg per year) c c S0S0 D S0S0 D 2.25 1.25 Price ($ per kg) b b $1 8 S1S1 a 2.75 1.75 6 d A B A d B S1S1 a

33. Price Controls A price floor is a minimum price set above the equilibrium price. It results in a surplus in the market. A price ceiling is a maximum price set below the equilibrium price. It results in a shortage in the market. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

34. Agricultural Price Supports Price supports for agricultural goods are an example of a price floor. They help overcome unstable agricultural prices. Farmers win from these supports. Consumers and taxpayers lose from these supports. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

35. Reasons for Price Supports Figure 3.12, page 74 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Market Demand and Supply Schedules for Wheat (millions of tonnes) Price ($ per tonne) Quantity Supplied Quantity Demanded (D)(S 0 )(S 1 ) $140 120 100 80 60 10 11 12 13 14 13 12 11 10 12 11 10 9 8 20 120 100 80 60 40 140 1234567891011121314 Quantity (millions of tonnes per year) 0 Price ($ per tonne) Market Demand and Supply Curves for Wheat S1S1 S0S0 D a b

36. Effects of Price Supports Figure 3.14, page 76 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. 0 58 59 60 Quantity (millions of litres per year) Market Demand and Supply Curves for Milk Price ($ per litre).70.90 1.10 1.30 S D 62 surplus Market Demand and Supply Schedules for Milk $1.30 1.10 0.90 60 59 61 60 62 58 (millions of litres) Price ($ per litre) A price floor creates a surplus. 61 Quantity Supplied (S) Quantity Demanded (D)

37. Rent Controls Rent controls are an example of a price ceiling. They keep down prices of controlled rental accommodation. Some (especially middle-class) tenants win from these controls. Other (especially poorer) tenants lose from these controls. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

38. Effects of Rent Controls Figure 3.15, page 77 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. 0 Quantity (units rented per month) Market Demand and Supply Curves for Units Price ($ per unit) 300 500 700 S D Market Demand and Supply Schedules for Units $700 500 300 2000 1700 2300 2000 2500 1500 (units rented per month) Price ($ rent per month) A price ceiling creates a shortage. 1500 2000 2500 shortage 2300 Quantity Supplied (S) Quantity Demanded (D)

39. Prophet of Capitalism’s Doom According to Karl Marx’s theory of exploitation: a product’s price is based on the amount of labour that goes into producing it capitalists cut costs by minimizing workers’ wages and by maximizing the length of the workday capitalists keep any surplus value, which is the excess of their revenues over their costs Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

40. Marx’s Theory of Exploitation Figure A, Page 84 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. $30$50 Creation of Surplus Value 0 80 Daily Wage Value produced ($ per day) 20 40 60 Creation of Surplus Value (when producing 2 shirts or 1 suit) Daily Wage Materials and machine wear and tear (M) Surplus Value (SV) Total Value Exploitation Rate (SV/W) $50 Wage $50 $10 $20 $80 2 5 $30 Wage $30 $10 $40 $80 4 3 W = 50 M = 10 SV = 10 SV = 40 W = 10 W = 30

41. The Economic Role of Government Besides intervening in private markets, Canadian governments have an independent role. Government programs include payments to adults with children, retirement funds for the elderly, unemployment insurance, welfare, higher education subsidies, free health care and schooling, and subsidized public housing. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

42. Federal Spending The main federal spending programs are: transfer payments to seniors (the Seniors Benefit) tax credits to low-income parents (the Child Tax Credit) transfer payments to the unemployed (Employment Insurance) pensions (the Quebec and Canada Pension Plans) Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

43. Provincial and Territorial Spending The responsibilities of provincial and territorial governments include: health care subsidies for post-secondary education welfare services The federal government pays a portion of these costs through the Canada Health and Social Transfer (CHST). Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

44. Government Expenditures Figure A, Page 87 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Goods and services Transfers to Persons Businesses Nonresidents Provinces and local Debt charges 58.2 75.9 3.8 4.4 55.9 31.5 229.8 Federal (2006) ($ billions) Goods and services Transfers to Persons Businesses Governments Debt charges 186.1 38.2 9.8 47.3 28.3 309.7 Provincial (2006) ($ billions) Goods and services Transfers to Persons Businesses Provinces Debt Charges 98.2 3.2 1.7 0.1 3.6 106.8 Local (2006) ($ billions)

45. Taxation (a) Canadian governments use five main types of taxation: Personal income taxes are levied by both federal and provincial governments, and are based on four marginal federal tax rates (15%, 22%, 26%, and 29%). Sales taxes are levied by both federal and provincial governments, and are charged as a percentage of price on a wide range of products. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

46. Taxation (b) Excise taxes are levied by both federal and provincial governments, and are usually charged as a dollar amount per unit of quantity on particular products. Property taxes are charged by local governments on buildings and land. Corporate income taxes are paid by corporations to both federal and provincial governments as a percentage of annual profits. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

47. Tax Revenues for All Levels of Government (2006) Figure B, Page 88 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Personal income taxes Sales and excise taxes Property taxes Corporate income taxes Miscellaneous taxes Percent of Gross Domestic Product 12.1 9.3 2.9 3.6 5.2 33.1 Percent of Total Taxes 36.3 28.2 8.8 10.9 15.7 100.0

48. Government Taxes and the Canadian Economy Figure C, Page 88 Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

49. Debates over Government’s Role (a) Taxes have increased significantly as a proportion of the total Canadian economy over the past few decades. Critics argue that taxes and some spending programs reduce productive activity. Critics also contend that many government programs are inequitable, and hampered by administrative problems. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

50. Debates Over Government’s Role (b) Supporters of government admit that public spending and taxation are not as effective as they could be. But they argue that these problems need to be seen in perspective, given that private markets are also subject to a variety of flaws. Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

51. Chapter 3 The End Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.