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ECON1: Lecture 7 (10/13/16)

by: Viola You

ECON1: Lecture 7 (10/13/16) ECON 1

Viola You

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Finishing chapter 5, starting chapter 6.
Principles of Economics
R. Rojas
Class Notes
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This 13 page Class Notes was uploaded by Viola You on Friday October 14, 2016. The Class Notes belongs to ECON 1 at University of California - Los Angeles taught by R. Rojas in Fall 2016. Since its upload, it has received 2 views. For similar materials see Principles of Economics in Economics at University of California - Los Angeles.


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Date Created: 10/14/16
Elasticity of Demand and Total Revenue Revenue = P x Q ● If demand is elastic then price elasticity of demand > 1 ○ % change in Q > % change in P ● The fall in revenue from lower Q is greater than the increase in revenue from  higher P, so revenue falls Demand for your websites: (any elasticity >1 would suffice) ● If demand is inelastic, then the price elasticity of demand < 1 ○ % change in Q < % change in P ● The fall in revenue from lower Q is smaller ● than the increase in revenue from higher P, so revenue rises. ● In our example, suppose that Q only falls to 10 (instead of 8) when you raise your price to $250.  Demand for your websites: (any elasticity <1 would suffice) Case Study: Does Drug Interdiction (Prohibition) Increase or Decrease Drug­Related Crime? ● One side effect of illegal drug use is crime: users often turn to crime to finance  their habit ● We examine two policies designed to reduce illegal drug use and see what  effects they have on drug­related crime ● For simplicity, we assume the total dollar value of drug­related crime equals total  expenditure ● Demand for illegal drugs is inelastic, due to addiction issues Elasticity of Supply The law of supply indicates a direct relationship between price and quantity supplied. ● How strong is that relationship? ● REVIEW: ○ Define elastic ­ a supply curve is elastic when an increase in price  increases the quantity supplied a lot (and vice versa) ○ Define inelastic ­ same, but a little Determinants of the Elasticity of Supply 1. Change in per­unit costs with increased production 2. Time horizon 3. Share of market for inputs 4. Geographic scope The more easily sellers can change the quantity they produce, the greater the price  elasticity of supply.  ● Example: Supply of beachfront property is harder to vary and thus less elastic  than supply of new cars. ● For many goods, price elasticity of supply is greater in the long run than in  the short run, because firms can build new factories, or new firms may be able to enter the market.  1. How quickly do per­unit costs increase when more is produced? ● If increased production is very expensive, then the supply curve will be inelastic ● If production can increase with little extra cost, then the supply curve will be  elastic 2. Time horizon matters ● IMMEDIATELY following a price increase, producers can expand output only  using their current capacity (making supply inelastic) ● Over time, producers can expand their capacity (making supply elastic) 3. The share of the market for the inputs used in production matters ● Supply is elastic when the industry can be expanded without causing a big  increase in the demand (and price) for the industry’s inputs ● Supply is inelastic when industry expansion causes a significant increase in  the demand/price for inputs 4. The geographic scope of the market matters ● The wider the scope of the market of a good, the less elastic its supply ○ National sales ● The narrower the scope of the market of a good, the more elastic its supply ○ Local stores, if one customer is lost it has greater effect Price Elasticity of Supply using the Midpoint Formula Use midpoint formula to erase natural bias associated with choice of base point Same rules of elasticity apply here How the Price Elasticity of Supply Can Vary Real­world example:  In the peak summer driving season, gasoline demand is highest. Many  refineries are producing near capacity, so the supply curve is steep. In other months, when  demand is lower, refineries have more excess capacity, and the supply curve is not as steep. Other Elasticities Define income elasticity of demand ­ measures the response of Q  to a Dhange in consumer  income REVIEW from Chapter 4:  An increase in income causes an increase in demand for a normal  good.  ● For normal goods, income elasticity > 0 ● For inferior goods, income elasticity < 0 The income elasticity of demand can be used to distinguish normal from inferior goods. ● For normal goods, Income Elasticityis po itive ● For luxury goods, Income Elasticity is greater than one ● For inferior goods, Income Elasticityis  egative Define cross­price elasticity of demand ­ measures the response of demand for one good to  changes in the price of another good ● For substitutes, cross­price elasticity > 0 ○ Ex: an increase in price of beef causes an increase in demand for  chicken ● For complements, cross­price elasticity < 0 ○ Ex: an increase in price of computers causes decrease in demand for software Cross­Price Elasticity of Demand ● For substitutes, Cross­Price Elasticity of Demand s positive. ○ An increase in the price of one brand of milk will increase the  demand for other brands. ● For complements, Cross­Price Elasticity of Demand is negative. ○ An increase in the price of milk causes a decrease in demand for  Oreos. *MIDTERM: 10/20 Thursday, in class* CHAPTER 6 ● How do taxes affect market outcomes? ● How do the effects depend on whether the tax is imposed on buyers or sellers? Price Controls Two types of price controls: ● Define price ceiling ­ a legal maximum on the price of a good or service ○ Ex: rent control ● Define price floor ­ a legal minimum on the price of a good or service ○ Ex: minimum wage Price Ceilings Policy makers may respond to buyers’ complaints that prices are “too high” by enacting price  controls such as a price ceiling ● Price ceilings limit the price sellers can charge for their goods to the maximum price ● Prices cannot legally go higher than the ceiling ○ Ex: when there’s a shortage Example: The market for apartments Over time, supply and demand are more price elastic; the curves start to flatten out: shortage  gets larger Price ceilings that involve a maximum price below the market price create five important  effects 1. Shortages 2. Reduction in product quality a. When we are at a low price ceiling (below equilibrium), there is no  incentive to provide better quality 3. Wasteful lines and other costs of search 4. Loss of gains from trade 5. Misallocation of resources


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