SURVEY OF ECONOMIC ANALYSIS

1
SURVEY OF ECONOMIC ANALYSIS

• LECTURE 5

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MAIN POINTS

• ELASTICITY OF DEMAND
• ELASTICITY OF SUPPLY
• SUBSTITUTION
• ELASTIC E LASTIC
• INELASTIC NELASTIC
• UNIT ELASTIC
• TOTAL REVENUE
• ARC ELASTICITY

3

• PER UNIT TAX
• MARKET CLEARING
• PRICE CEILING
• PRICE FLOOR

4
DEFINITION OF ELASTICITY

• ELASTICITY SHOWS THE RESPONSE OF THE QUANTITY
  DEMANDED OR QUANTITY SUPPLIED TO A CHANGE IN
  PRICE.
• SUBSTITUTION

EASY- ELASTIC
DIFFICULT- INELASTIC
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PRICE ELASTICITY OF DEMAND

• CHANGE IN QUANTITY DEMANDED
• CHANGE IN PRICE

ED
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PRICE ELASTICITY OF DEMAND
NOTE MOVEMENT ALONG A GIVEN DEMAND CURVE

• CHANGE IN QUANTITY DEMANDED
• CHANGE IN PRICE

ED
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CALCULATION OF ELASTICITY OF DEMAND

• CHANGE
• IN QUANTITY - Ed ( CHANGE IN PRICE)
• DEMANDED
• WHY IS Ed A NEGATIVE NUMBER ?

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• Ed ( Q2 - Q1)/Q1 / ( P2 - P1 ) / P1

Ed D Q / Q / ( DP / P)
(P/Q) (DQ / DP)
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• Ed ( Q2 - Q1)/Q1 / ( P2 - P1 ) / P1

Ed D Q / Q / ( DP / P) (P /
Q) ( DQ / DP)
SLOPE OF THE DEMAND CURVE WHICH ACCORDING TO
THE LAW OF DEMAND IS NEGATIVE
10
Theoretical Formulation
1
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Computational Formula
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DETERMINANTS OF THE ELASTICITY OF DEMAND

• NUMBER AND CLOSENESS OF SUBSTITUTES
• NECESSITIES OR LUXURIES
• LENGTH OF THE TIME PERIOD TO WHICH THE DEMAND
  CURVE PERTAINS

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PRICE ELASTICITY AND TOTAL REVENUE

• TR PQ
• Ed 1 (DQ/Q) (DP/P)

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PRICE ELASTICITY AND TOTAL REVENUE

• TR PQ
• Ed 1 (DQ/Q) (DP/P) E LASTIC
  

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PRICE ELASTICITY AND TOTAL REVENUE

• TR PQ
• Ed 1 (DQ/Q) (DP/P) E LASTIC
• TR P

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PRICE ELASTICITY AND TOTAL REVENUE

• TR PQ
• Ed 1 (DQ/Q) (DP/P) E LASTIC
• TR P
• Ed 1 (DQ/Q) (DP/P)

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PRICE ELASTICITY AND TOTAL REVENUE

• TR PQ
• Ed 1 (DQ/Q) (DP/P) E LASTIC
• TR P
• Ed 1 (DQ/Q) (DP/P) UNITARY

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PRICE ELASTICITY AND TOTAL REVENUE

• TR PQ
• Ed 1 (DQ/Q) (DP/P) E LASTIC
• TR P
• Ed 1 (DQ/Q) (DP/P) UNITARY
• TR P

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PRICE ELASTICITY AND TOTAL REVENUE

• TR PQ
• Ed 1 (DQ/Q) (DP/P) E LASTIC
• TR P
• Ed 1 (DQ/Q) (DP/P) UNITARY
• TR P
• Ed

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PRICE ELASTICITY AND TOTAL REVENUE

• TR PQ
• Ed 1 (DQ/Q) (DP/P) E LASTIC
• TR P
• Ed 1 (DQ/Q) (DP/P) UNITARY
• TR P
• Ed

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PRICE ELASTICITY AND TOTAL REVENUE

• TR PQ
• Ed 1 (DQ/Q) (DP/P) E LASTIC
• TR P
• Ed 1 (DQ/Q) (DP/P) UNITARY
• TR P
• Ed
• TR P

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Other Revenue Measures
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PRICE ELASTICITY OF SUPPLY

• CHANGE IN QUANTITY SUPPLIED
• CHANGE IN PRICE

Es
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PRICE ELASTICITY OF SUPPLY
NOTE MOVEMENT ALONG A GIVEN SUPPLY CURVE

• CHANGE IN QUANTITY SUPPLIED
• CHANGE IN PRICE

Es
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CALCULATION OF ELASTICITY OF SUPPLY

• CHANGE
• IN QUANTITY Es ( CHANGE IN PRICE)
• SUPPLIED
• WHY IS Es A POSITIVE NUMBER ?

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• Es ( Q2 - Q1)/Q1 / ( P2 - P1 ) / P1

Es D Q / Q / ( DP / P)
(P/Q) / (DQ / DP)
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• Es ( Q2 - Q1)/Q1 / ( P2 - P1 ) / P1

Es D Q / Q / ( DP / P)
(P/Q) / (DQ / DP)
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• Es ( Q2 - Q1)/Q1 / ( P2 - P1 ) / P1

Es D Q / Q / ( DP / P) (P /
Q)/ ( DQ / DP)
SLOPE OF THE SUPPLY CURVE WHICH ACCORDING TO THE
LAW OF SUPPLY IS POSITIVE
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Computational Formula
30
RANGES OF SUPPLY CURVE
PERFECTLY INELASTIC/ FULL CAPACITY
S
PRICE
RELATIVELY ELASTIC
PERFECTLY ELASTIC/ EXCESS CAPACITY
QUANTITY
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SHORT-RUN SUPPLY CURVE
PRICE
QUANTITY
32
SHORT-RUN SUPPLY CURVE
PRICE
LONG-RUN SUPPLY CURVE
QUANTITY
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PRICE
S
P
D2
D1
Q1
Q2
QUANTITY
INFINITELY ELASTIC SUPPLY CURVE
34
AN EXCESS DEMAND DOES NOT OCCUR SO THE PRICE
DOES NOT CHANGE. NO SIGNAL TO THE MARKET TO
CHANGE THE PRICE.
PRICE
S
INFORMATION OR DATA
P
D2
D1
Q1
Q2
QUANTITY
INFINITELY ELASTIC SUPPLY CURVE
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AN EXCESS DEMAND DOES NOT OCCUR SO THE PRICE
DOES NOT CHANGE. NO SIGNAL TO THE MARKET TO
CHANGE THE PRICE.
PRICE
TOTAL OUTPUT RESPONSE
S
INFORMATION OR DATA
P
D2
D1
Q1
Q2
QUANTITY
INFINITELY ELASTIC SUPPLY CURVE
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S
PRICE
P2
P1
D2
D1
Q
QUANTITY
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S
PRICE
EXCESS DEMAND OCCURS SO PRICE CHANGES
P2
P1
SIGNAL TO RATION OUTPUT
D2
D1
Q
QUANTITY
ZERO ELASTICITY OF SUPPLY
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S
PRICE
EXCESS DEMAND OCCURS SO PRICE CHANGES
P2
TOTAL PRICE RESPONSE
P1
SIGNAL TO RATION OUTPUT
D2
D1
Q
QUANTITY
ZERO ELASTICITY OF SUPPLY
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HIGHLY ELASTIC SUPPLY CURVE
S
P1
D1
Q1
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HIGHLY ELASTIC
S
P2
P1
D2
D1
Q1
Q2
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HIGHLY ELASTIC
S
P2
P1
LARGE CHANGE IN QUANTITY
D2
D1
Q1
Q2
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HIGHLY ELASTIC
SMALL CHANGE IN PRICE
S
P2
P1
LARGE CHANGE IN QUANTITY
D2
D1
Q1
Q2
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HIGHLY INELASTIC SUPPLY CURVE
S
P1
D1
Q1
44
HIGHLY INELASTIC SUPPLY CURVE
S
P2
P1
D2
D1
Q1
Q2
45
HIGHLY INELASTIC SUPPLY CURVE
S
P2
SMALL CHANGE IN QUANTITY
P1
D2
D1
Q1
Q2
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HIGHLY INELASTIC SUPPLY CURVE
S
LARGE CHANGE IN PRICE
P2
SMALL CHANGE IN QUANTITY
P1
D2
D1
Q1
Q2
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HIGHLY ELASTIC DEMAND CURVE
S1
P1
D
Q1
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HIGHLY ELASTIC DEMAND CURVE
S1
S2
P1
P2
D
Q1
Q2
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HIGHLY ELASTIC DEMAND CURVE
S1
S2
LARGE CHANGE IN QUANTITY
P1
P2
D
Q1
Q2
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HIGHLY ELASTIC DEMAND CURVE
SMALL CHANGE IN PRICE
S1
S2
LARGE CHANGE IN QUANTITY
P1
P2
D
Q1
Q2
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HIGHLY INELASTIC DEMAND CURVE
S1
P1
D
Q1
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HIGHLY INELASTIC DEMAND CURVE
S1
S2
P1
P2
D
Q1
Q2
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HIGHLY INELASTIC DEMAND CURVE
S1
S2
P1
SMALL CHANGE IN QUANTITY
P2
D
Q1
Q2
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HIGHLY INELASTIC DEMAND CURVE
S1
S2
LARGE CHANGE IN PRICE
P1
SMALL CHANGE IN QUANTITY
P2
D
Q1
Q2
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Applications of Elasticity
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Per Unit Tax
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S0 PRE-TAX
PRE-TAX PRICE
P0
D
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
P1
PER-UNIT TAX
PRE-TAX PRICE
P0
P1
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
PRICE PAID BY CONSUMER
P1
PRE-TAX PRICE
P0
P1
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
PRICE PAID BY CONSUMER
P1
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
D
Q0
Q1
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Consumer and Producer Surplus
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
PRICE PAID BY CONSUMER
P1
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
PRICE PAID BY CONSUMER
P1
GOVT TAX RECEIPTS
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
PRICE PAID BY CONSUMER
P1
GOVT TAX RECEIPTS
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
TAXES PAID BY CONSUMERS
PRICE PAID BY CONSUMER
P1
GOVT TAX RECEIPTS
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
TAXES PAID BY CONSUMERS
PRICE PAID BY CONSUMER
P1
GOVT TAX RECEIPTS
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
TAXES PAID BY PRODUCERS
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
TAXES PAID BY CONSUMERS
PRICE PAID BY CONSUMER
P1
GOVT TAX RECEIPTS
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
TAXES PAID BY PRODUCERS
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
TAXES PAID BY CONSUMERS
PRICE PAID BY CONSUMER
P1
DEAD-WEIGHT LOSS DUE TO THE TAX
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
TAXES PAID BY PRODUCERS
D
Q0
Q1
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Elasticity and the Consumer and Producer Surplus
70
ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
PRICE PAID BY CONSUMER
P1
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
PRICE PAID BY CONSUMER
P1
PRE-TAX PRICE
P0
P1
PRICE RECEIVED BY PRODUCER
D
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
D
S0 PRE-TAX
PRICE PAID BY CONSUMER
P1
CONSUMERS PAY THE ENTIRE TAX
P0
PRE-TAX PRICE
PRICE RECEIVED BY PRODUCER
Q0
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
PRICE PAID BY CONSUMER
PRE-TAX PRICE
P0
D
P1
PRICE RECEIVED BY PRODUCER
Q0
Q1
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ELASTICITY OF DEMAND AND A PER UNIT TAX
S1 AFTER-TAX
S0 PRE-TAX
PRICE PAID BY CONSUMER
PRE-TAX PRICE
P0
D
PRODUCERS PAY THE ENTIRE TAX
P1
PRICE RECEIVED BY PRODUCER
Q0
Q1
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Rent Control and Price Ceilings in Competitive
Markets
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SSHORT-RUN
RENT
MARKET CLEARING RENT
R
D
NUMBER OF APARTMENTS
QA
77
SSHORT-RUN
RENT
MARKET CLEARING RENT
SHORTAGE OR EXCESS DEMAND IN THE SHORT-RUN
R
RC
RENT CEILING
D
QDA
NUMBER OF APARTMENTS
QA
QSA
78
SSHORT-RUN
RENT
SLONG-RUN
MARKET CLEARING RENT
SHORTAGE OR EXCESS DEMAND IN THE LONG-RUN
R
RC
RENT CEILING
D
QDA
QSLA
NUMBER OF APARTMENTS
QA
QSA
79
Minimum Wage As a Price Floor
80
S
WAGE
W
MARKET CLEARING WAGE
D
QL
QUANTITY OF LABOR
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S
WAGE
WMIN
W
MARKET CLEARING WAGE
D
QL
QDL
QSL
QUANTITY OF LABOR
82
EXCESS SUPPLY OF LABOR UNEMPLOYMENT
S
WAGE
WMIN
W
MARKET CLEARING WAGE
D
QL
QDL
QSL
QUANTITY OF LABOR
83
Increasing Labor Force And The Minimum Wage
84
S
WAGE
S
WMIN
EXCESS SUPPLY OF LABOR UNEMPLOYMENT
W
MARKET CLEARING WAGE
D
QL
QDL
QSL
QUANTITY OF LABOR
85
Income Elasticity of Demand
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Income Elasticity of Demand is defined as
Percentage Change in Quantity Demanded Percentage
Change in Income

EI
-
0
87

• EI (Q2 Q1)/Q1 (M2 -M1)/M1
• D Q / Q D M / M
• D Q / Q M/ D M
• M / Q D Q / D M

88

• EI (Q2 Q1)/Q1 (M2 -M1)/M1
• D Q / Q D M / M
• D Q / Q M/ D M
• M / Q D Q / D M

Slope of the Engel curve
The Engel Curve is a function showing the
relationship between money income and the
quantity of a good consumed.
89
Computational Formula
90
Q Quantity
EM 1
EM 1
EM
M (Nominal Income)
Engel Curve
91

• Normal Goods - A good is a normal good if its
  income elasticity is positive. This means that
  when income rises, quantity demanded rises most
  goods are normal goods.
• Necessity Goods - A good is a necessity if its
  income elasticity is positive, but less than 1.
  This means that if income rises by 10, quantity
  demanded rises by less than 10 - therefore, as
  people's income rises, they spend a smaller
  percentage of their income on necessities.
• Luxury Goods - A good is a luxury good if its
  income elasticity is positive, and greater than
  1. This means that if income rises by 10,
  quantity demanded rises by more than 10 -
  therefore, people spend more of their income on
  luxuries when they have larger incomes.

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Inferior Goods - A good is an inferior good if
its income elasticity is negative. This means
that when income rises, quantity demanded falls.
For inferior goods the Engel curve has an
unusual negative slope.
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Cross Elasticity of Demand is defined as
Percentage Change in Quantity Demanded of Good
X Percentage Change in Price of Good Y

-
Ec
0

94

• Ec (Qx2 Qx1)/Qx1 (Py2 -Py1)/Py1
• D Qx / Qx D Py / Py
• D Qx / Qx Py/ D Py
• Py / Qx D Qx / D Py

95

• Ec (Qx2 Qx1)/Qx1 (Py2 -Py1)/Py1
• D Qx / Qx D Py / Py
• D Qx / Qx Py/ D Py
• Py / Qx D Qx / D Py

Slope of the Functions We Discussed in Lecture 4
96
Computational Formula
97
If Ec 0 , the goods are classified as
substitutes.
If Ec 0, the goods are said to be independent.
If Ec complements
98
Ec 0
Py
Ec 0
Price of Good Y
Ec
Qx
Quantity of Good X