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Technology Lahore
Che-309
Instructor: Aamir Abbas
2
Price elasticity of demand
It is a measure of how much the quantity
demanded of a good responds to a change in
the price of that good, computed as the
percentage change in quantity demanded
divided by the percentage change in price.
3
Elastic and inelastic demand
Demand for a good is said to be elastic if the
quantity demanded responds substantially to
changes in the price.
4
Price elasticity of demand
5
Price elasticity of demand
Demand is elastic when the elasticity is greater than 1, so that quantity moves
proportionately more than the price.
6
Price elasticity of demand
Demand is inelastic when the elasticity is less than 1, so that quantity moves
proportionately less than the price.
7
Price elasticity of demand
9
Price Ceilings & Price Floors
Price Ceiling
A legally established maximum price at which a
good can be sold. (Rent Controls)
Price Floor
A legally established minimum price at which a
good can be sold. (Price Supports for Agriculture)
10
Price Ceilings
Two outcomes are possible when the
government imposes a price ceiling:
The price ceiling is not binding if set above
the equilibrium price.
11
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Price of
Ice-Cream
Cone
Supply
$4 Price
ceiling
Equilibrium
price
Demand
0 100 Quantity of
Equilibrium Ice-Cream
quantity Cones 12
Harcourt, Inc. items and derived items copyright © 2001 by Harcourt, Inc.
Equilibrium
price
$3
2 Price
ceiling
Shortage
Demand
0 75 125 Quantity of
Quantity Quantity Ice-Cream
supplied demanded Cones 13
Case study for gasoline
• In 1973 OPEC raised the price of crude.
• The higher oil prices reduced the supply of
gasoline.
• Before increase in price by OPEC, price of
gasoline was below price ceiling so no effect.
• With increase in price of crude situation
changed, reduced the supply of gasoline due
increase in cost of crude.
• Result shortage.
14
The Price Ceiling on Gasoline Is Not Binding...
Price of
Gasoline
1. Initially, Supply
the
price ceiling
is not
binding... $4 Price
ceiling
P1
Demand
0 Quantity of
Q1 Gasoline
15
The Price Ceiling on Gasoline Is Binding...
Price of S2 2. …but
Gasoline when supply
falls...
S1
P2
Price
ceiling
P1 3. …the price
ceiling becomes
4. …resulting binding...
in a shortage.
Demand
0 Quantity of
Q1 Gasoline
16
Effects of Price Ceilings
A binding price ceiling creates,
nonprice rationing
Examples: Long lines, Discrimination by sellers
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What are some potential impacts of
taxes?
Taxes are used to raise money for the
government.
Taxes discourage market activity.
When a good is taxed, the quantity sold is
smaller.
Buyers and sellers share the tax burden.
But finally who bears the burden-tax
incidence.
18
Copyright © 2001 by Harcourt, Inc. All rights reserved
Price
sellers
receive
Demand, D1
0 90 100 Quantity of 19
Ice-Cream Cones
Copyright © 2001 by Harcourt, Inc. All rights reserved
Price of
Ice-Cream
Cone Supply, S1
Price
buyers
pay $3.30 Equilibrium without tax
Price 3.00 Tax ($0.50)
without 2.80
tax
Price
Equilibrium
sellers with tax
receive
D1
D2
0 90 100 Quantity of 20
Ice-Cream Cones
The Incidence of Tax
In what proportions is the burden of the tax
divided?
How do the effects of taxes on sellers compare
to those levied on buyers?
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“In this world nothing is certain but death and taxes.”
. . . Benjamin Franklin
100
Today, taxes
80
account for up
60
to a third of
40
the average
American’s
20
income.
0
1789 Today
22
Summary
Price elasticity of demand.
Price floor and ceiling.
Bonding and non-binding effect.
Taxes
23