Ch. 15 Market Demand (contd)
III. Income Elasticity of Demand
Outline
I.
Market Demand
II.
Price Elasticity of Demand
†
a.
b.
III.
Definition:
Definition
Relationship with revenue
Income Elasticity of Demand
0
1
η
1
Income Elasticity of Demand (contd.)
†
†
2
Income Elasticity of Demand (contd.)
η=%change in demand/%change in income
η=
†
Find η when D(p)= 91 +m/2 - p/2, and p=2
†
Find η when D(p)= m/2p
3
4
5
6
Motivation
†
Ch. 16 Equilibrium
Two fundamental principles of microeconomic
analysis
„
„
†
Optimization
Equilibrium
Optimization
†
†
Consumers
Producers
=> demand function
=> supply function
8
7
Outline
I. Supply Curve S(p)
Supply Curve and Elasticity
Competitive Equilibrium
Comparative Statics
Taxation
I.
II.
III.
IV.
i.
ii.
‰
Definition:
‰
†
Who pays the tax?
Dead weight loss
p
The supply curve
demonstrates how much
the industry is willing to
supply of a good at each
market price p.
Slope?
q
9
10
Supply Elasticity
†
†
†
Supply Elasticity
єS –Price elasticity of supply
єS =%change in supply/%change in price
єS =
†
†
†
11
0<єS <1: Supply is inelastic/elastic?
єS =1: Supply is unit elastic
єS >1: Supply is inelastic/elastic?
Perfectly inelastic
Perfectly elastic
12
Finding the price elasticity of supply
†
Finding the price elasticity of supply
What is єS when S(p)=3p?
†
What is єS when S(p)=-2+p and p=3?
13
II: Competitive Equilibrium
†
†
II: Competitive Equilibrium
Assume a large number of buyers and sellers who all
take the price as given
Definition:
„
„
14
p
A competitive equilibrium is a (p*,q*) such that quantity
demanded equals quantity supplied
i.e., a (p*,q*) such that S(p*)=D(p*)=q*
q
15
16
II: Competitive Equilibrium
II: Competitive Equilibrium
p>p* Excess supply
p<p* Excess demand
17
18
Example (contd)
Example: D(p)=16-2p and S(p)=-2 +p
†
Find p where D(p)=S(p):
12
10
8
Demand
Supply
6
4
2
0
0
2
4
6
8
10
12
14
16
19
Example: D(p)=16-2p and S(p)=-2 +p
†
Excess supply at p=7>p*:
†
Excess demand at p=3<p*:
20
Oil crisis 1973 and 1979
†
Argued that shortage of oil due to OPEC countries
cutting production: True/False?
21
II: Competitive equilibrium (contd.)
†
†
22
II: Competitive equilibrium (contd.)
Equilibrium (p*,q*) jointly determined by the positioning of
the demand and supply curve.
Exceptions when demand or supply perfectly inelastic or
elastic
If one side of market perfectly inelastic => determines q*
If one side of market perfectly elastic => determines p*
†
†
p
D(p)
p
S(p)
p*
D(p)
S(p)
q
Supply perfectly inelastic
q
q*
Supply perfectly elastic
23
Demand perfectly inelastic
Demand perfectly elastic
24
III: Comparative Statics
†
†
III: Comparative Statics (contd.)
Comparing equilibria that result under
different sets of parameters
Why do prices of some goods like apples
decrease during heavy consumption, while
others like beachfront cottages increase
during heavy consumption?
Shift in supply
Shift in demand
S(p)
S(p)
p*
p*
D(p)
D(p)
q*
e.g., price of input increases
q*
e.g., program change increases demand
25
Great Plains Labor Market
†
26
IV. Taxation
Why might fluctuations in wages be greater in
Iowa?
p
†
Let
„
„
„
„
qS-quantity supplied
qD-quantity demanded
pS-price suppliers face
pD-price demanders face
D’
D
q
27
Example: D(p)=16-2p and S(p)=-2+p impose a
$3 quantity tax on suppliers
Example: D(p)=16-2p and S(p)=-2+p impose a $3
quantity tax on suppliers
15
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
pS = pD – 3
qD= 16 – 2pD
qS= -2 +pS
qD= qS
Demand
Supply
Supply
0
2
4
6
8
10
12
14
28
16
29
30
IV: Taxation continued
†
Unit tax imposed on supplier
„
„
„
„
†
Taxation (contd)
†
pS= pD-t
qS= qD
Transactions take place at pD
Supply curve shifts to the left
†
Is the equilibrium sensitive to who has the
legal burden of paying the tax?
Taxes are on transactions not on individuals
Unit tax imposed on demander
„
„
„
„
pD= pS+t
qS= qD
Transactions take place at pS
Demand curve shifts to the left
31
IV.I. Who Pays the Tax? Example: D(p)=16-2p and S(p)=-2+p
impose a $3 quantity tax on suppliers
15
14
13
12
11
10
9
8
7
6
5
4
3
2
1
0
Who bears the larger share of the tax burden?
Demand
New Supply
Supply
0
2
4
6
8
10
12
14
32
†
Relatively elastic supply
†
Perfectly Elastic supply
16
33
The less elastic side of the market pays
a higher proportion of the tax
Who bears the larger share of the tax burden?
†
Relatively inelastic supply
34
p
†
†
†
†
Perfectly Inelastic supply
p
q
tD =pD-p*
tS =p*-pS
Find
„
tD / tS = єS /|єD |
p
S
pD
pS
D
q
q’
q
35
36
The less elastic side of the market pays
a higher proportion of the tax
tD / tS = єS /|єD |:
†
†
†
†
tD / tS = єS /|єD |
tD > tS if єS >|єD |
tD < tS if єS <|єD |
Consider extreme cases
„
„
єD=0 or єS=0
єD→-∞ or єS→∞
p
S’
S
pD
pS
D
q
q’
37
38
39
40
Example: D(p)=16-2p and S(p)=-2+p, $3
quantity tax. Who paid the tax?
†
†
†
†
Original equilibrium: (p*, q*)=(6,4)
After tax equilibrium: (p*, q*)=(7,2)
$1 of tax paid by consumer, and $2 paid by
producer
Which side of the market it most elastic?