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This document summarizes key concepts relating to demand, supply, and market equilibrium. It defines elasticity as the responsiveness of one variable to changes in another. It then discusses different types of elasticity including own-price elasticity, cross-price elasticity, and income elasticity. The document also covers the determinants of price elasticity, applications such as tax incidence and price controls, and concepts like consumer and producer surplus.
This document summarizes key concepts relating to demand, supply, and market equilibrium. It defines elasticity as the responsiveness of one variable to changes in another. It then discusses different types of elasticity including own-price elasticity, cross-price elasticity, and income elasticity. The document also covers the determinants of price elasticity, applications such as tax incidence and price controls, and concepts like consumer and producer surplus.
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This document summarizes key concepts relating to demand, supply, and market equilibrium. It defines elasticity as the responsiveness of one variable to changes in another. It then discusses different types of elasticity including own-price elasticity, cross-price elasticity, and income elasticity. The document also covers the determinants of price elasticity, applications such as tax incidence and price controls, and concepts like consumer and producer surplus.
Авторское право:
Attribution Non-Commercial (BY-NC)
Доступные форматы
Скачайте в формате PPTX, PDF, TXT или читайте онлайн в Scribd
MARKET EQUILIBRIUM (Part 2) Economics 11- UPLB Prepared by T.B.Paris, Jr. 11/28/07
Elasticity Concepts Meaning of elasticity: If Y=f(X), elasticity measures the responsiveness of Y due to changes in X. A given change in X brings about a change in Y. The elasticity measure attempts to compare the relative change in Y with to the relative change in X. Mathematical formulation: % / % / Y Y Y X X X c A A = = A A Elasticity Values 0 Perfectly inelastic 1 Inelastic 1 Unit elastic 1 Elastic Perfectly elastic c c c c c = < = > = The elasticity values (in absolute terms) can range from zero to infinity; each with definite interpretations. 3 Demand Elasticity Concepts We shall study 3 demand elasticity concepts: Own price elasticity : responsiveness of quantity demanded of a good to changes in own-price. Cross price elasticity responsiveness of quantity demanded of good A to changes in price of good B (substitute or complement) Income elasticity responsiveness of quantity demanded of a good due to changes in income. Own-Price Elasticity Own price elasticity of demand () measure of responsiveness of quantity demanded to changes in price % % inQ d inP c A = A Two ways of measuring elasticity Point elasticity elasticity is measured for a single point More precise since elasticity changes at every point on demand curve Can be obtained if demand function is known Arc elasticity computed for two points along a demand curve Done if we have limited number of observations
Point Elasticity 0 Q
P
P r i c e
Quantity Q 1 D
A
P 1 % / % / slope P/Q d d d Q Q Q Q P P P P P Q c c A A A = = = A A A = Arc Elasticity Q 2 0 Q
P
P r i c e
Quantity Q 1 D
A
P 1 P 2 B
2 1 2 1 2 1 2 1 Diff Q Diff P Sum Q Sum P Q Q P P Q Q P P c c
= + + = Arc Elasticity: Example 200
0 Q
P
P r i c e
Quantity 100
D
A
30
20
B
200-100 30-20 200+100 30+20 100 10 1 5 5/ 3 1.66 300 50 3 1 c c = = = = = Elasticity Along a Linear Demand Curve Unit Elastic Elastic Inelastic P P 1 Q 1 0 Q
Q
P
P r i c e
Quantity D D Elasticity goes down as you move down along a linear demand curve. The upper half is elastic, the lower half is inelastic. At the mid-point of the demand curve, elasticity is unitary. Geometric derivation of B O Q
D
P
P r i c e
Quantity C A E % / % / Q Q Q Q P P P P P Q DC BD DC BD OD OD BC AB c c c A A A = = = A A A = = = Geometric derivation of BC AB c = B A C P Q 0 Elastic at B B A C P Q 0 Inelastic at B Demand function: Qd = 20 - 2P Price Quantity Slope Elasticity 10 0 -2 9 2 -2 -9.00 8 4 -2 -4.00 7 6 -2 -2.33 6 8 -2 -1.50 5 10 -2 -1.00 4 12 -2 -0.67 3 14 -2 -0.43 2 16 -2 -0.25 1 18 -2 -0.11 0 20 -2 0.00 Special Case: Perfectly Inelastic Demand Curve: 0 Q
P
P r i c e
Quantity D
A vertical demand curve implies that any change in price will not lead to a change in quantity demanded. % 0 0 % d Q P c A = = = A + Special Case: Perfectly Elastic Demand Curve: 0 Q
P
P r i c e
Quantity D
A horizontal demand curve implies that a very small change in price will lead to an infinitely large change in quantity demanded. % % 0 d Q P c A + = = = A Elasticity and Total Revenue Total revenue (from the point of view of a seller) is equal to the quantity sold multiplied by the price. TR = P x Q It is of interest to the seller what happens to his TR if he raises or lowers his price, knowing that if he does, consumers will adjust their purchases. What happens to TR when price increases? Answer: it depends on the elasticity of demand
Elastic P Q TR decreases Unitary P Q TR unchanged Inelastic P Q TR increases % % Q P c A = A What happens to TR when price decreases? Answer: it depends on the elasticity of demand Elastic P Q TR increases Unitary P Q TR unchanged Inelastic P Q TR decreases % % Q P c A = A Determinants of price elasticity of demand
(1) the availability of good substitutes for the commodity more substitutes, more elastic (2) the number of uses the good can be put into more uses, more elastic (3) the price of the good relative to the consumer's purchasing power if good takes a larger share of budget, likely to be more elastic (4) the time frame under consideration longer period of time, more elastic (5) location along the demand curve. recall ideas on elasticity and the linear demand curve Cross Price Elasticity of Demand Definition: responsiveness of quantity demand of a good to changes in price of other goods. Formula:
Sign: + for substitutes, - for complements
% % dx xy y Q e P A = A Income Elasticity of Demand Definition: responsiveness of quantity demanded of a good to changes in income
Formula:
Sign: + for normal goods - for inferior goods
% % dx xI Q I q A = A Some Applications Minimum Price Policy floor prices to protect producers (price support) or workers (minimum wage) Maximum Price Policy price ceilings to protect consumers (fares, rice price, LPG price, etc. Tax Incidence who bears the burden when tax is imposed on the producer? Minimum price policies prices cannot go below a specified price E.g. price support for agricultural commodities, minimum wages floor price is usually set above the equilibrium price and it causes a surplus Floor Price (minimum price policy) P f Q 1 0 Q
Q*
P
P r i c e
Quantity S D P*
surplus To be effective, a floor price (P f ) must be set above the equilibrium price(P*) Examples: Minimum wages, price support for rice farmers Maximum price policy (price ceiling) price cannot be set above a specified price Example: maximum fares allowed public transport operators Usually set below the equilibrium price and causes a shortage Price Ceiling (maximum price policy) P f Q 1 0 Q
Q*
P
P r i c e
Quantity S D P*
shortage To be effective, a price ceiling (P f ) must be set below the equilibrium price(P*) P c Examples: Price control of rice, rents, LPG Tax incidence Concerned with effects of government tax policies on consumption and production. The tax could either be a specific or excise tax or an ad valorem tax. specific tax or excise tax tax per unit of the product ad valorem tax tax as percentage of the selling price. Tax incidence Question: Who bears the greater portion of tax? Is it the consumer or the producer? Supply and demand analysis of a specific tax: the tax is likely to be paid for by producers and consumers the tax is likely to raise the equilibrium price, but by an amount less than the tax. Tax Incidence Q 0 0 Q
P
P r i c e
Quantity S 0 D P 0 S 1 tax P 1 P 1+ t P 0+ t Q 2 Q 1 Tax Incidence Q 0 0 Q
P
P r i c e
Quantity S 0 D P 0 S 1 tax P 0+ t If demand is Perfectly Inelastic : all of the tax is passed on to consumers. Tax Incidence: Perfectly Elastic Demand Q 0 0 Q
P
P r i c e
Quantity S 0 D P 0 S 1 tax If demand is Perfectly Elastic : all of the tax burden is borne by the producer. Q 1 Consumer Surplus 0 Q
P
P r i c e
Quantity Q 1 D
P 1 S 1 Consumer surplus: difference between what a consumer is willing to pay and what he actually pays for the good. Consumer Surplus 0 Q
P
P r i c e
Quantity Q 1 D
P 1 S 1 S 2 When market price decreases, consumer surplus becomes bigger P 2 Q 2 S 2 S 2 P 2 S 2 P 2 S 2 P 2 S 2 Q 2 P 2 S 2 Producer Surplus 0 Q
P
P r i c e
Quantity Q 1 D
P 1 S 1 Producer surplus: difference between what a producer receives (market price) and the amount that will motivate him to supply the product (marginal costs must be recovered). End Chapter 3