1. CHAPTER 3: MARKET EFFICIENCY & ELASTICITY
3.1 The Market System
3.2 Constraint on the Market: Government Intervention
3.3 Market Efficiency & Surpluses Maximization
3.4 Elasticity

2. Consumers (Demand) Firms (Supply)
Microeconomics scope for UBEA 1013 Economics
Output (Product) Market
DD & SS Interaction
Consumers
(Demand)
Firms
(Supply)
Changes in DD / SS:
Equilibrium Price & Quantity
Production
Supplier surplus
Factors effect SS
Elasticity
Market structure
Utility (excluded)
Consumer surplus
Factors effect DD
Elasticity
Market System
Market Efficiency
Government Intervention

3. Stability or equilibrium point:
3.1 The Market System
Stability or equilibrium point:
supply = demand
This situation achieved and re-achieved after disequilibrium through the an important functions of the market (price system):
PRICE RATIONING

4. Figure 3.1: Price Rationing
3.1 The Market System
Price Rationing:
Definition:
i. Allocates output to consumers and resources to firms through price adjustment.
ii. Price rationing when Qty DD > Qty SS (shortage)
iii. Allocation based on willingness & ability to pay (answering the “for whom to produce” problem).
Figure 3.1: Price Rationing

5. Price rationing is consider as market oriented approach because:
3.1 The Market System
Note:
Price rationing is consider as market oriented approach because:
i. Allocates through open market
ii. No government intervention
Weaknesses (market failure): Inability to recognize that each society have the right, necessity or needs to certain type of outputs like health care, accommodation, basic food and safety
lottery approach, political approach and mixed approach
Use non-market / non-pricing approach
government intervention

6. Situations of Market failure:
3.1 The Market System
Situations of Market failure:
a) External benefit:
i. Free-riders
ii. Road (transport), hospital (public health), dam (flood/electricity)
b) External cost:
i. Negative effect/cost to others
ii. Pollution
c) Imperfect information:
i. Seller has more info than buyer
ii. “Lemon market” & info disclosure
d) Imperfect competition:
i. Market controlled by monopoly, cartel, illegal co- operation
ii. Government ownership, law & regulation

7. 3.2 Constraint on the Market: Case for Government Intervention
a) Price ceiling:
i. Maximum price sellers may charge
ii. To control unjust high price
iii. Excess demand (Ration coupon as complement action to control DD)
iv. Emerging of black market
Figure 3.1 (Price Ceiling at $3.27)

8. 3.2 Government Intervention
b) Ration coupon:
i. Ticket/coupon entitle individual to purchase
ii. Coupons trading – alike price rationing
iii. Serve as redistributing income
c) Favored customer:
i. Special treatment
ii. Results in hidden cost
d) Waiting in line (Queuing):
i. Product cost = cost of waiting
ii. A form of deadweight loss

9. 3.2 Government Intervention
e) Price floor:
i. Minimum price for buying – selling
ii. To adjust unfair low price
iii. Excess of supply (government has to buy up excess)
iv. Alternative: subsidization
Figure 3.2: Price Floor: Minimum Wages
f) Other restriction:
i. Price control
ii. Licensing
iii. Taxes
iv. Quota

10. 3.3 Market Efficiency & Surpluses Maximization
What is “Efficient Market”?:
i. Pareto efficient: A market is efficient if there is no way to make any person better off without hurting anybody else. (Relate to PPF)
ii. Relate to PPF: Reduce production of product “Y” to increase production of product “X”.

11. 3.3 Efficiency & Surpluses
What is “Consumer Surplus”?:
i. Extra value individual received
ii. What people willing to pay
iii. Maximum amount willing to pay minus current market price
Figure 3.3: Consumer Surplus

12. 3.3 Efficiency & Surpluses
What is “Producer Surplus”?:
i. Extra value producer received
ii. What producer pay for the right to sell at current price
iii. Minimum amount willing to sell minus current market price
Figure 3.4: Producer Surplus

13. 3.3 Efficiency & Surpluses
Surplus maximization:
i. Market efficient = maximize sum of consumer & producer surpluses
ii. Achieved when DD = SS
Figure 3.5(a): Surplus maximization

14. 3.3 Efficiency & Surpluses
Deadweight loss:
i. Losses of consumer and producer surplus that are not transferred to other parties
ii. Occur from under and over production
Figure 3.5(b): Deadweight loss
(under production)
Figure 3.6: Deadweight loss
(over production)

15. Figure 3.5(a): Demand Curve Slope & Responsiveness
3.4 Elasticity
A measure of how “responsive” demand is to some change in price or income:
i. The slop of a demand function (∆q/∆p)
ii. The slope of the demand curve (∆p/∆q)
iii. Elasticity method
Figure 3.5(a): Demand Curve Slope & Responsiveness

16. Elasticity is a general concept to:
i. quantify the response in one variable when another variable changes
ii. measure the percentage change in one variable brought about by a 1 percent change in some other variable
iii. Elasticity is unit free
Type of elasticity:
i. Price elasticity of demand
ii. Income elasticity
iii. Cross-price elasticity

17. ε = [(∆q/q)*100%] / [(∆p/p)*100%] ………… (Equation 3.1)
3.4 Elasticity
Price elasticity of demand calculation: How responsive consumers are to changes in the price of a product
ε = [(∆q/q)*100%] / [(∆p/p)*100%] ………… (Equation 3.1)
= (∆q/q)*100% * (p/∆p)*(1/100%)
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
Slope of
demand
function
Ratio of
price to
quantity
multiply

18. ε = (p/q)*(∆q/∆p) …………… (Equation 3.2) = (3/5)*[(10 – 5)/(2 – 3)]
3.4 Elasticity
Example: Use Figure 3.7 (a) & (b). Assumed price decrease from P1 = $3 to P2 = $2.
For Figure 3.7 (a):
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
= (3/5)*[(10 – 5)/(2 – 3)]
= – 3 or
Same answer for Figure 3.7 (b):
proving that different unit of measurement did not effect elasticity.

19. Solution: Mid-point formula
3.4 Elasticity
BUT different answer if assumed price increase from P1 = $2 to P2 = $3.
Solution: Mid-point formula

20. NOTE: Which one is more elastic?
3.4 Elasticity
NOTE: Which one is more elastic?
More elastic
Less elastic
In negative
value
– 5
– 4
– 3
– 2
– 1
Less elastic
More elastic
In absolute
value 1 2 3 4 5

21. Table 3.1 shows values & types for elasticity of demand
Figure 3.8(a): Perfectly Inelastic
Figure 3.8(b): Perfectly Elastic
Table 3.1 shows values & types for elasticity of demand

22. Elasticity of linear demand curve: i. Change from point to point
ii. Decrease when move downward
iii. Elastic at upper range, inelastic at lower range
Figure 3.9: Elasticity of a Linear Demand Curve
At middle point, elasticity = 1

23. Calculus proving (No. 1): Consider a linear demand curve, q = a – bp
3.4 Elasticity
Calculus proving (No. 1):
Consider a linear demand curve, q = a – bp
i. The slope = – b
ii. If q = 0; p = a / b (price intercept)
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
= (p/q)* (– b)
= [p / (a – bp)]* [– b] (›› q = a – bp)
– 1 = [p / (a – bp)]* [– b] (unitary elasticity)
– 1 = (– bp) / (a – bp)
bp = (a – bp)
2bp = a
p = a / 2b
(middle point)
p = a / b

24. Calculus proving (No. 2):
3.4 Elasticity
Calculus proving (No. 2):
Linear demand curve, q = a – bp
At price axis intercept, q = 0 & p = a / b
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
= [(a/b) / 0]* (– b)
= ∞ (›› infinity elasticity at price intercept)
p = a / b

25. Calculus proving (No. 3):
3.4 Elasticity
Calculus proving (No. 3):
Linear demand curve, q = a – bp
At quantity axis intercept, p = 0 & q = a
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
= (0/a)*(– b)
= (›› zero elasticity at qty intercept)
p = a / b a

26. Price increase < Qty drop ›› increase price = reduced revenue
3.4 Elasticity
Price increase < Qty drop
›› increase price = reduced revenue
Price increase = Qty drop
›› revenue maximization
Price increase > Qty drop
›› increase price = increase revenue

27. ε = [(∆q/q)*100%] / [(∆p’/p’)*100%]
3.4 Elasticity
Cross price elasticity:
Measure of the response of the quantity of one good demanded to a change in the price of another good
ε = [(∆q/q)*100%] / [(∆p’/p’)*100%]
For substitute product: ε(p’) positive (the price of one product and quantity demanded for another product move in the same direction)
For complement product: ε(p’) negative (the price of one product and quantity demanded for another product move in the opposite direction)

28. 3.4 Elasticity
Others elasticity:
Elasticity of supply is a measure of the response of quantity of a good supplied to a change in price of that good. Its value is likely to be positive in output markets due to the law of supply.
Elasticity of labor supply is a measure of the response of labor supplied to a change in the price of labor
End