ECON 300 PPT CH - 03

Understanding Economics
6th edition
by Mark Lovewell
Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.
6th edition
by Mark Lovewell
Chapter 3
Competitive Dynamics and
Government
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.
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

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

Elastic and Inelastic
Demand (b)
Figure 3.1 Page 61
Elastic Demand Curve Inelastic Demand Curve
for Ice Cream Cones for Ice cream Cones
2.40 2.40
Price ($ per cone)
20% 20%
Price ($ per cone)

2.00 2.00
1.60 D1 1.60 D2
50%
10%
1.20 1.20
0.80 0.80
0.40 0.40
0 500 1000 0 500 1000 1800 2000
Quantity Demanded Quantity Demanded

(cones per winter month) (cones per summer month)

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.

Perfectly Elastic and Perfectly Inelastic Demand (b)
Figure 3.2 Page 62
Perfectly Elastic Perfectly Inelastic

Demand Curve Demand Curve
for Soybeans for Insulin D4
Price ($ per tonnes)
Price ($ per tonnes)

1.60 D3
0 0 1000
Quantity Demanded Quantity Demanded

(tonnes) (litres)

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.

Revenue Changes with Elastic
Demand
Figure 3.3 Page 63
Price ($ to rent a DVD) Demand Curve for DVDs
5
4 A
3
D
2
B C
1
0 500 1000 1500
Quantity Demanded (DVDs rented each day)

Revenue Changes with Inelastic
Demand
Figure 3.4 Page 64
Demand Curve for Amusement Park Rides
5
Price ($ per ride)
4
3
E
2
D
1 F G
0 2000 4000 6000 8000 10 000

Quantity Demanded (riders each day)

Total Revenue and the Price Elasticity of Demand (b)
Figure 3.5 Page 64
Demand Elasticity and Changes in Total Revenue
Price Change in
Change Total Revenue
Elastic Demand up down

down up
Inelastic Demand up up
down down
Unit-Elastic Demand up unchanged

down unchanged

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)

Calculating Price Elasticity of
Demand
A numerical value for price elasticity of
demand (ed) is found by taking the ratio of the
changes in quantity demanded and in price,
each divided by its average value.
In mathematical terms:
ed = Qd average Qd
price average price

Elasticity and a Linear Demand
Curve (a)
A linear demand curve has a different price
elasticity (ed) 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 ed.
At low prices, the change in quantity
demanded (price) is relatively small (large)
relative to average quantity demanded, giving
a small ed.
Elasticity and a Linear Demand
Curve (b)
Figure 3.6 Page 67
Market Demand Curve for Sodas
Market Demand Schedules

for Sodas 5
ed > 1
Price Quantity Price
Price ($ per soda)

4
Demanded Elasticity
($ per of Demand
soda) (millions of sodas) (ed) 3 ed = 1
5 0
9.00 2
4 1 ed < 1
2.33
3 2 1
1.00
2 3
0.43
1 4
0.11 0
0 5 1 2 3 4 5
Quantity Demanded
(millions of sodas)

Income Elasticity
Income elasticity (ei) is the responsiveness of
a products quantity demanded to changes in
consumer income.
ei = Qd average Qd
I average I

Cross-Price Elasticity
Cross-price elasticity (ei) is the
responsiveness of the quantity demanded of
one product (x) to a change in price of
another (y).
exy = Qd average Qd
Py average Py

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.

Elastic and Inelastic Supply
Figure 3.7, Page 70
Elastic Supply Curve Inelastic Supply Curve
for Tomatoes For Tomatoes
4 4
Price ($ per kilogram)

S1 S2
3 3
50% 50%
2 2
100% 20%
1 1
0 100 000 120000 0 100 000 120 000
Quantity Supplied Quantity Supplied

(kilograms per year) (kilograms per year)

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.

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.

Time and the Price Elasticity of Supply (b)
Figure 3.8, Page 71 (continued in part (e))
Immediate-Run Short-Run
Supply Elasticity Supply Elasticity
for Strawberries For Strawberries
S2
2.50
Price ($ per kilograms)

S1
2.00
0 750 000 0 9 11
Quantity Supplied Quantity Supplied

(kilograms per month) (millions of kilograms per year)

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.

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.

Supply (e)
Figure 3.8, Page 71 (continued from part (b))
Long-Run Supply Elasticity
Price ($ per kilograms)

S4
Constant-
2.00 S3
cost Industry
Increasing-
cost Industry
Quantity Supplied
(millions of kilograms per decade)

Calculating Price Elasticity of
Supply
A numerical value for price elasticity of supply
(es) is found by taking the ratio of the changes
in quantity supplied and in price, each divided
by its average value.
es = Qs average Qs
price average price

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 (S0) seen by producers.
The reason for this difference is that the price
as seen by consumers is now higher than that
seen by producers.

Excise Taxes (b)
The after-tax price for consumers is found
where S1 crosses the demand curve. The after-
tax equilibrium price for producers is the
corresponding price on S0.
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.

The Impact of an Excise
Tax
Figure 3.9, page 74
The Impact of an Excise Tax
Market Demand and Supply S1

4.00
Curves For Strawberries 3.50
b S0
Price 3.00
Quantity Quantity
a $1
Demanded Supplied 2.50
Price ($ per kg)

($ per (D) (S0) (S1) A
tonne) 2.00
(millions of tonnes) B c
1.50 d
3.00 5 13 9
1.00
2.50 7 11 7 D
2.00 9 9 5 0.50
1.50 11 7 3
1.00 13 5 1 0 1 3 5 7 9 11 13 15
Quantity (millions of kg per year)

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.

Excise Taxes and Demand Elasticity
Figure 3.10, page 75
Elastic Demand S1 Inelastic Demand S1
S0
b
b
S0
a
a 2.75 $1
$1
2.25 A
c
Price ($ per kg)
Price ($ per kg)

A
2.00 2.00 c
B
B D 1.75 d
d
1.25
6 9 8 9
Quantity (millions of kg per year) Quantity (millions of kg per year)

Excise Taxes and Supply Elasticity
Elastic Supply Inelastic Supply S1
S0
b
S1
b
a $1
2.75 a
Price ($ per kg)
Price ($ per kg)

$1 S0
A 2.25
A
2.00 2.00 c
1.75 B c
d B
D 1.25
d
D
6 9 8 9
Quantity (millions of kg per year) Quantity (millions of kg per year)

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.

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.

Reasons for Price
Supports
Market Demand and Supply
Curves for Wheat
S1 S0
Schedules for Wheat 140
b
Price 120
Quantity Quantity
Price ($ per tonne)

Demanded Supplied 100 a
($ per (D) (S0) (S1)
tonne) 80
(millions of tonnes)
60 D
$140 10 14 12
40
120 11 13 11
100 12 12 10 20
80 13 11 9
60 14 10 8 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Quantity (millions of tonnes per year)

Effects of Price
Supports
Market Demand and Supply Curves
for Milk
Schedules for Milk surplus
S
Price Quantity Quantity 1.30
Price ($ per litre)

($ per Demanded Supplied
litre) (D) (S) 1.10
(millions of litres)
.90
$1.30 59 62 A price floor
.70 creates D
1.10 60 60 a surplus.
0.90 61 58
0 58 60 61 62
59
Quantity
(millions of litres per year)

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.

Effects of Rent Controls
Figure 3.15, page 80 Market Demand and Supply
Curves for Units
Schedules for Units
S
Price Quantity Quantity 700
Price ($ per unit)

($ rent Demanded Supplied A price ceiling
per (D) (S) creates
500
a shortage.
month) (units rented per month)
300
$700 1700 2500
500 2000 2000 D
shortage
300 2300 1500
0 1500 2000 2300 2500
Quantity
(units rented per month)

Prophet of Capitalisms
Doom
According to Karl Marxs theory of
exploitation:
a products 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

Marxs Theory of Exploitation
Figure A, Page 87
Creation of Surplus Value Creation of Surplus Value

(when producing 2 shirts or 1 suit)
Value produced ($ per day)

$50 Wage $30 Wage 80
Daily Wage $50 $30 W = 50 W = 30
60
Materials and $10 $10
machine wear W = 10
40
and tear (M)
Surplus Value (SV) $20 $40 M = 10
20
Total Value $80 $80 SV = 10 SV = 40
Exploitation Rate 2 4
0 $50 $30
(SV/W) 5 3
Daily Wage

For the Public Good (OLC)
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.

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)

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).

Government Expenditures
Figure A
Federal (2009) Provincial (2009) Local (2009)
($ billions) ($ billions) ($ billions)
Goods and services 63.9 Goods and services 214. Goods and 109.
Transfers to Transfers to 1 services 1
Persons 87.9 Persons Transfers to
Businesses 4.5 Businesses 43.1 Persons 4.0
Nonresidents 4.8 Governments 11.1 Businesses 2.2
Provinces and local 65.1 Debt charges 52.5 Provinces 0.1
Debt charges 26.1 28.3 Debt Charges 3.5
253.1 349. 118.
2 9

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.

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.

Tax Revenues for All Levels of Government (2009)
Figure B
Percent of Percent of
Gross Domestic Total Taxes
Product
Personal income 37.6
taxes 11.5 28.4
Sales and excise 8.7 10.5
taxes 3.2 8.2
Property taxes 2.5 15.0
Corporate income 4.6 100.0
taxes
30.5
Miscellaneous taxes

Taxes and the Canadian Economy
Figure C

Debates over Governments 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.

Debates Over Governments 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.

6th edition
by Mark Lovewell
Chapter 3
The End
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

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Understanding Economics

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

Price ($ per cone)

0 500 1000 0 500 1000 1800 2000

Quantity Demanded Quantity Demanded

Copyright 2012 by McGraw-Hill Ryerson

quantity demanded and a vertical demand

Copyright 2012 by McGraw-Hill Ryerson

Perfectly Elastic Perfectly Inelastic

Price ($ per tonnes)

Quantity Demanded Quantity Demanded

Copyright 2012 by McGraw-Hill Ryerson

change in the same direction when demand is

when demand is unit-elastic.

Copyright 2012 by McGraw-Hill Ryerson

Price ($ to rent a DVD) Demand Curve for DVDs

0 500 1000 1500

Quantity Demanded (DVDs rented each day)

Copyright 2012 by McGraw-Hill Ryerson

Demand Curve for Amusement Park Rides

0 2000 4000 6000 8000 10 000

Copyright 2012 by McGraw-Hill Ryerson

Demand Elasticity and Changes in Total Revenue

Elastic Demand up down

Unit-Elastic Demand up unchanged

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Copyright 2012 by McGraw-Hill Ryerson

Copyright 2012 by McGraw-Hill Ryerson

Market Demand Schedules

Price ($ per soda)

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Copyright 2012 by McGraw-Hill Ryerson

Price ($ per kilogram)

0 100 000 120000 0 100 000 120 000

Quantity Supplied Quantity Supplied

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quantity supplied and a vertical supply curve.

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Copyright 2012 by McGraw-Hill Ryerson

Price ($ per kilograms)

Quantity Supplied Quantity Supplied

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Long-Run Supply Elasticity

Price ($ per kilograms)

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Market Demand and Supply S1

Price ($ per kg)

Quantity (millions of kg per year)

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Copyright 2012 by McGraw-Hill Ryerson

Price ($ per kg)

Quantity (millions of kg per year) Quantity (millions of kg per year)

Copyright 2012 by McGraw-Hill Ryerson

Price ($ per kg)