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EC 201 Week 3 Notes

by: Annie Notetaker

EC 201 Week 3 Notes Econ 201

Annie Notetaker
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These notes cover all of week 3. Monday 10/10/16 and Wednesday 10/12/16
Introduction to Microeconomics
Erica Birk
Class Notes
Econ, Economics, Microeconomic, EC201, ECON201
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This 10 page Class Notes was uploaded by Annie Notetaker on Thursday October 13, 2016. The Class Notes belongs to Econ 201 at University of Oregon taught by Erica Birk in Fall 2016. Since its upload, it has received 25 views. For similar materials see Introduction to Microeconomics in Microeconomics at University of Oregon.


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Date Created: 10/13/16
EC 201- Erica Birk: Week 3, Chapter 4 Mon 10/10/16 Suppose inverse demand is p(Q ) = 40-Q and inverse supply is p(Q ) = Q -2 s s What is the new outcome of a $2 tax imposed on each unit sold? • Shifts supply curve to the left • Lower equilibrium quantity • Higher equilibrium price Find equilibrium price without tax 1. Set equations equal to each other d s 40-Q = Q -2 Q = 42-Q At equilibrium, Q = Q d 2Q = 42 Q* = 21 2. Plug the price back into either equation d 40-Q 40-(21) = 19 p(21) = $19 Find equilibrium price with the tax 1. Set the equations equal to each other d s 40-Q = Q -2+2 40-Q = Q s 2Q = 40 Q* = 20 2. Plug the price back into either equation d 40-Q 40-(20) = 20 p(20) = $20 The price increases by $1 with the tax With a supply increase, we see quantity increase, and with a demand increase, we quantity increase. If both increase, it must be the case that quantity increases 1. Unambiguous increase in equilibrium quantity With a supply increase we see a price fall, but with a demand increase we see a price increase. What happens to the price in this scenario? 2. Ambiguous change in price If the shift in the demand curve is bigger than the shift in the supply curve, the price increases If the shift in the supply curve is bigger than the shift in the demand curve, the price decreases 1. Unambiguous decrease in equilibrium prices 2. Ambiguous change in quantity If decrease in supply dominates, we see higher price but lower quantity If decrease in demand dominates, we see both lower price and lower quantity Both the demand curve and the supply curve have two ways that they can shift Elasticity Elasticity: A measure of the responsiveness of buyers and sellers to changes in prices or income • Items that do not have ready substitutes and/or are hard to live without will be less sensitive to price changes than other items • Some goods respond heavily to prices, while other goods do not How does the quantity demanded for a good change when the price of the good changes? Price Elasticity of Demand: A measure of the responsiveness of quantity demanded to a change in price 2 If the quantity demanded changes significantly due to a price change, we say the good is elastic (i.e. Snickers Bars) If the quantity demanded changes only slightly due to a price change, we say the good is inelastic (i.e. Medicine) One key determinant of whether a good is elastic or not is how many substitutes that good has Ex.: The price of Snickers Bars triples. Most people will stop buying Snick ers Bars and switch to another candy because there are so many choices What about EpiPen? There are currently no substitutes on the market Another key determinant of the price elasticity of demand is the share of the budget spent on that good *In elasticity, we talk about percentage changes, not dollar changes, in prices Ex.: We need 3 Scantrons for this course, one for eac h midterm and one for the final Scantron sheets are $0.25 each. How likely are you to look for a 10% sale on Scantron sheets? Assuming you said not very likely, you demonstrated that items you do not spend a large portion of your income on become inelastic Ex.: Textbooks are an elastic good because they represent a large share of your budget Economists consider some goods to be “luxury good s.” Things we want but don’t need. They are relatively elastic Other goods are necessities which you must have. When buying these, you generally are considering the need, not the price. They are inelastic. (i.e. medical care, clean water, food) Immediate Run: There is no time for consumers to adjust their behavior - inelastic (i.e. buying gas wherever you can find it, if it’s the most expensive place) 3 Short Run: A period of time when consumers can partially adjust their behavior- somewhat elastic (i.e. pick a cheaper gas station) Long Run: A period of time when consumers can fully adjust their behavior- elastic (buy a car with better gas mileage, ride a bike, etc.) Price Elasticity of Demand: ED = percentage change in quantity demanded/percentage change in price Ex.: The price went up by 10% and the quantity demanded fell by 20%. Plug the numbers into the formula: E = -20D10, E = -2 D • A good is elastic if |E | D 1 or the percent change in quantity demanded is greater than the percent change in price • A good is inelastic if |E | <D1 or the percent change in quantity demanded is less than the percent change in price What if instead of percent changes, we have a demand schedule? Price Quantity Demanded $1 30 $2 10 The price falls from $2 to $1 *To avoid the problem of getting multiple, differing answers, economists use the midpoint method, which gives you the same answer, regardless of where you start ED = (change in quantity/average value of quantity)/(change in price/average value of price) ED = {(Q 2Q )1[(Q +1 )/22}/{(P -P 2/[(1 +P )12]}2 Use the midpoint method to solve the demand table above P = $2 Q = 10 1 1 P = $1 Q = 30 2 2 (30-10)/[(30+10)/2] (1-2)/[(1+2)/2] = 20/20 = -1/(3/2) = 1 = -2/3 4 ED = 1/(-2/3) = -3/2 |-3/2| > 1 The good is elastic Elasticity can be seen on graphs on the demand curve Relatively flat demand curves represent elastic demand curves, whereas steep demand curves represent inelastic demand curves Extreme examples: Perfectly inelastic demand curve: E = 0D Perfectly elastic demand curve: E = -Dnfinity The closer the slope is to being horizontal, the more elastic it is However, elasticity and slope are different An individual demand curve can have different elasticities on it, depending on where you are on the curve Income Elasticity of Demand: Measures how a change in income affects spending 5 EC 201- Erica Birk: Week 3, Chapter 4 Wed 10/12/16 Price Elasticity of Demand If there are 20 million cigarette packs sold in a week, how much revenue will a new $0.25-per-pack tax generate for the government? • $5 million IF quantity demanded did not change BUT, quantity demanded will change, because the price of cigarettes will rise to accommodate the tax • The government will earn less than $5 million If the government wants to bring in revenue, they would want to tax inelastic goods, because the quantity-demanded will be less likely to change (From last class) Income Elasticity of Demand: Measures how a change in income affects spending EI= percentage change in quantity demanded/percentage change in income Still use midpoint method: E = {IQ -Q )2[(Q1+Q )/1]}/{2I -I )/[(2 1I )/21} 2 What do we expect the sign on E to beI Think about a normal good: If income increases (so the denominator of E is posItive), what do we expect to happen to the quantity demanded (is the numerator of E positive or1 negative)? We demand more of it: positive Think about an inferior good: If income increases (so the denominator of E is positive), what do we expect I to happen to the quantity demanded (is the numerator of E positive or1 negative)? We demand less of it: negative 6 Normal goods can be broken into two categories: Necessities and Luxuries Necessity: Has an income elasticity of demand that is positive, but less than one. People buy necessities even when their income is low, so the amount they buy doesn’t change significantly when their income increases. Luxury: Has an income elasticity greater than one. People only buy these goods when they have plenty of income to afford them Ex.: Percentage change in income = -10%, Percentage change in quantity demanded = -20% -20/-10 = 2 EI= 2 Empirical World: Item Income Elasticity Medical Services 0.22 Automobiles 3.00 Rental Housing 1.00 Owner Occupied Housing 1.20 Gasoline 1.06 Coffee 0.51 Marijuana 0.00 Gambling 1.00 • Lower values are more inelastic goods (usually necessities) • Higher values are more elastic goods (usually luxuries) • Elasticities at exactly 1.00 are technically neither a necessity nor a luxury. They are, however, normal goods The demand for a good depends on the price of related goods. How does quantity demanded respond to a change in the price of other goods? Cross-Price Elasticity of Demand: Measures the responsiveness of the quantity demanded of one good to a change in the price of a related good EC = percentage change in quantity demanded of the good of interest/percentage change in the price of a related good E = {(Q -Q )/[(Q +Q )/2]}/{(P -P )/[(P +P )/2]} C 2G1 1G1 1G1 2G1 2G2 1G2 1G2 2G2 7 *If the price of one good goes up, and the demand for a related good goes up, then they are substitutes Ex.: If the price of prescription drugs is raised from $4 -$5 and the amount of heroin demanded goes from 100lbs-200lbs, what is the cross-price elasticity? {(200-100)/[(100+200)/2]}/{(5-4)/[(4+5)/2]} = 3 Consider an empirical world: Item Cross-Price Elasticity Q dof butter and P of margarine 1.53 Q dof electricity and P of natural gas 0.50 Q dof coffee and P of tea 0.15 Q dof hard liquor and P of beer -0.11 • Positive cross-price elasticity suggests that two items are substitutes • Negative cross-price elasticity suggest that two items are not substitutes How quantity supplied responds to price Price Elasticity of Supply: Measures how quantity supply responds to changes in price The price elasticity of supply is always positive Supply is: • Perfectly inelastic if the price elasticity of supply is equal to zero • Relatively inelastic if it is less than one • Relatively elastic if it is greater than one ES = percentage change in the quantity supplied/percentage change in price The Flexibility of Producers: Some firms cannot respond to changes in prices as well as others Timing: If it takes considerable time to produce a good, then firms can’t respond very quickly to changes in price 8 Remember that both supply and demand matter in equilibrium. Be careful when considering the price elasticity of supply Price Controls Price Controls: Attempts to set prices through government involvement in a market • Price controls, or attempts to have them, have existed for a long time • In general, price controls interrupt the normal activity of the market, and often have negative consequences Perfect Markets: • Homogenous goods • No barriers to entry • Infinite buyers and sellers • Perfect Information Price controls can reduce the overall welfare of the markets Price Ceiling: A legally established maximum price for goods/services Price Floor: A legally established minimum price goods/services Reasons for the government setting a price ceiling: 1. To keep necessary goods affordable: Such as electricity, food, water, etc., especially after a natural disaster, when people really need these items 2. To help control inflation: If inflation starts to get out of hand, the government may implement laws to help control it 3. Any number of political or social reasons Price ceiling examples: Rent Control: Price ceiling that applies to the housing market Price Gouging Laws: Temporary price ceilings placed on the prices that sellers can charge during an emergency situation 9 Non-Binding Price Ceiling: A price ceiling with the price set above equilibrium price- Does not matter to us as consumers. In a naturally- functioning market, it has no effect, since it is above the equilibrium Binding Price Ceiling: A price ceiling set below the equilibrium price- Even though market forces would allow you to, you cannot legally charge a price higher than the ceiling. As consumers, we demand t han we did when the price was at equilibrium. Suppliers, however, will supply less than the equilibrium quantity would be = Shortage Shortages lead to black markets, because consumers are willing to pay a lot for the good/service 10


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