ECON 0100 Lecture Notes - Lecture 3: Deadweight Loss, Economic Surplus
Chapter 6
Elasticity
A unit free measurement of responsiveness to changes in prices or income.
Gives us the tools necessary to make QUANTITATIVE statements about the
effects of a price or income change.
§
○
Because it is unit free, elasticity makes it easier to compare different goods.
○
Can also be useful for firms and governments when setting prices and implementing
policies.
○
EXAMPLE
Suppose Good X's price fell from $5 to $4 and the quantity demanded increased
from 80K to 100K units. Good Y's price increased from $18 to $20 and the
quantity demanded decreased from 75K to 70K.
§
In which market is demand more sensitive to changes in price?
§
Solution
§
○
•
Price Elasticity of Demand (εD)
Measures how quantity demanded responds to change in price
○
Equation
○
εD=
§
Midpoint method for % change in X
○
•
Practice
Suppose that a price increase in milkshakes from $4 to $6 causes the quantity
demanded to fall from 110K to 90K. Use the midpoint method to calculate the
elasticity of demand.
§
○
We say that demand is:
ELASTIC if small change in Price --> big change in Quantity Demanded.
This is true if the price elasticity of demand is εD___ 1.
□
§
INELASTIC if big change in Price --> small change in Quantity Demanded.
This is true if the price elasticity of demand is εD___ 1.
□
§
UNIT ELASTIC if % change in Price = % change in Quantity Demanded .
This is true if the price elasticity of demand is εD___ 1.
□
§
○
Perfectly Elastic
If any change in Price will make Quantity Demanded equals ZERO or INFINITY.
§
○
Perfectly Inelastic
If change in Price will have no effect on the Quantity Demanded
§
○
PRACTICE
Suppose the price elasticity of demand is 1.5 & the price increases by 2%. What
happens to quantity demanded?
§
○
Suppose the government wants to decrease the number of cars that use Fort
Duquesne Bridge by imposing a fee. The fee will be most effective at reducing
traffic congestion if the price elasticity of demand for using the bridge is:
Elastic
a.
Inelastic
b.
Unit Elastic
c.
Impossible to tell without more information
d.
§
Price Elasticity of Demand along Demand Curves
When we talk about a specific value for price elasticity of demand, we mean AT A
SPECIFIC PRICE.
○
For many demand curves, the price elasticity of demand varies along the demand
curve.
○
•
Demand & Total Revenue
Total Revenue
Price x Quantity
§
○
As price increases from $1 to $2, Total Revenue ___________ from ____ to ____
○
The area A is ___________________. The area C is ________________________.
○
•
As price increases from $5 to $6, Total Revenue ___________ from ____ to ____
○
The area A is ___________________. The area C is ________________________.
○
Price Elasticities of Demand
•
Real-World Estimated Price
Elasticities of Demand
Eggs
0.32
Milk
0.63
Soft Drinks
0.79
Gasoline (in the long run)
0.24
Housing
1.2
Restaurant Meals
2.3
Airline Travel (Leisure)
1.5
Foreign Travel
4.1
Cross-Price Elasticity of Demand
Between Goods X and Y (εX,Y)
○
The cross-price elasticity of demand measures the responsiveness of Quantity
Demanded to Change in Price of ANOTHER GOOD.
○
Equation
○
•
εX,Y =
§
Interpretation
If εX,Y < 0, the goods are ______________.
§
If εX,Y > 0, the goods are ______________.
§
If εX,Y = 0, the goods are ______________.
§
○
Income Elasticity of Demand (εI)
The income elasticity of demand measures the responsiveness of Quantity Demanded
to Change in Income.
○
Equation
○
•
εI=
§
Interpretation
If εI< 0, the goods are ______________.
§
If εI> 0, the goods are ______________.
§
If εI> 1, the goods are ______________.
§
○
Price Elasticity of Supply (εS)
Measures how quantity supplied responds to change in price
○
Equation
○
εS=
§
We say that supply is:
ELASTIC if small change in Price --> big change in Quantity Supplied.
This is true if the price elasticity of supply is εS___ 1.
□
§
INELASTIC if big change in Price --> small change in Quantity Supplied.
This is true if the price elasticity of supply is εS___ 1.
□
§
UNIT ELASTIC if % change in Price = % change in Quantity Supplied.
This is true if the price elasticity of supply is εS___ 1.
□
§
○
Perfectly Elastic
If any change in Price will make Quantity Supplied equals ZERO or INFINITY.
§
○
Perfectly Inelastic
If change in Price will have no effect on the Quantity Supplied
§
○
•
Factors that affect Price Elasticity of Supply
Availability of Inputs
More inputs ---> _________ elastic
□
§
Time
More time ---> _________ elastic
□
§
○
Practice Problems
If a price decreased from $60 to $40 causes quantity demand to increase from 6 to
12, what happens to total revenue? Using what you know about price elasticity of
demand and total revenue. Is demand elastic, inelastic, or unit elastic?
○
•
Suppose that 5% increase in the price of widgets leads to a 15% decrease in the
quantity of gadgets. What is the cross price elasticity of demand? Using this, what
can you conclude about widgets and gadgets?
○
The perfectly elastic demand curve is ____.
○
The perfectly inelastic demand curve is ____.
○
___ is relatively more elastic than ____.
○
TRICK: Think Efor elastic & Ifor inelastic.
Notice that A ____ C.
○
In the inelastic region of demand, an
increase in Price will ________ Total Revenue.
Why?
▪
○
% change in Quantity Demanded is _______
than % change in Price.
○
Thus, added revenue from increase in Price
is __________ the lost revenue from decrease
of Quantity Demanded.
○
Notice that A ____ C.
○
In the elastic region of demand, an increase
in Price will ________ Total Revenue.
Why?
▪
○
% change in Quantity Demanded is _______
than % change in Price.
○
Thus, added revenue from increase in Price
is __________ the lost revenue from decrease
of Quantity Demanded.
○
Many factors affect demand elasticity
Necessity vs Luxury
Necessity more _______
○
Luxury more _______
○
•
Availability of Close Substitutes
as number of substitutes
increase, more _________
○
•
Share of Income
As income share increases,
more ___________
○
•
Time Frame
As time increases, more
________
○
•
The perfectly elastic supply curve is ____.
○
The perfectly inelastic supply curve is ____.
○
___ is relatively more elastic than ____.
○
TRICK: Think Efor elastic & Ifor inelastic.
Chapter 7
Taxes
Common type of taxes seen by individuals include:
Income taxes
§
Social insurance taxes
§
Property taxes
§
Excise taxes (per unit tax on good or service)
This is what we are going to be focusing on
□
§
○
Using the tools we have learned to date, we will focus on analyzing the effects
on an excising tax. The main questions are
What happens to the market equilibrium?
§
What happens to the welfare?
§
Who actually pays the taxes?
§
○
•
When the Tax is Levied on the Supplier
Consider the market for Hotel Rooms
○
•
When the Tax is Levied on the Consumer
Consider the Market for Hotel Rooms
○
•
Effect on Welfare
Before the tax
Consumer Surplus =
§
Producer Surplus =
§
Total Surplus =
§
○
•
Taxes and Elasticity
The burden of an excise tax mainly falls on more inelastic side of the market
○
Example of $2 tax when demand is relatively more _______ than supply
○
Burden
For Demand =
§
For Supply =
§
○
•
Example of $2 tax when demand is relatively more _______ than supply
○
Burden
For Demand =
§
For Supply =
§
○
Elasticity and Deadweight Loss of a Tax
Taxes create deadweight loss because they affect the mutually beneficial
trades
○
As demand and/or supply become more inelastic, DWL from, taxes _______
○
•
Q* = P* =
Suppose the government decided to
charge SUPPLIERS a $40 per room
tax.
○
Effective price for suppliers is P-$40
so supply curve shifts up by the
amount of tax to reflect this.
○
Q*tax = P*tax =
Buyers pay ____, Sellers receive ____
○
Thus, the effect of tax
On suppliers is ______
○
On buyers is ______
○
○
Q* = P* =
Suppose the government decided to
charge CONSUMERS a $40 per room
tax.
○
Buyers pay P+$40
○
Thus, the demand curve shifts down
by $40 to reflect this.
○
Q*tax = P*tax =
Buyers pay ____, Sellers receive ____
○
Thus, the effect of tax
On suppliers is ______
○
On buyers is ______
○
○
Suppose the government decided to
charge a $40 per room tax (doesn't
matter who is charged the tax!)
○
CStax =
○
PStax =
○
Govt. Revenue =
○
TStax = CStax + PStax + GR =
○
DWL =
○
Lecture 3
Wednesday,+May+23,+2018
2:19+PM
Chapter 6
Elasticity
A unit free measurement of responsiveness to changes in prices or income.
Gives us the tools necessary to make QUANTITATIVE statements about the
effects of a price or income change.
§
○
Because it is unit free, elasticity makes it easier to compare different goods.
○
Can also be useful for firms and governments when setting prices and implementing
policies.
○
EXAMPLE
Suppose Good X's price fell from $5 to $4 and the quantity demanded increased
from 80K to 100K units. Good Y's price increased from $18 to $20 and the
quantity demanded decreased from 75K to 70K.
§
In which market is demand more sensitive to changes in price?
§
Solution
§
○
•
Price Elasticity of Demand (εD)
Measures how quantity demanded responds to change in price
○
Equation
○
εD=
§
Midpoint method for % change in X
○
•
Practice
Suppose that a price increase in milkshakes from $4 to $6 causes the quantity
demanded to fall from 110K to 90K. Use the midpoint method to calculate the
elasticity of demand.
§
○
We say that demand is:
ELASTIC if small change in Price --> big change in Quantity Demanded.
This is true if the price elasticity of demand is εD___ 1.
□
§
INELASTIC if big change in Price --> small change in Quantity Demanded.
This is true if the price elasticity of demand is εD___ 1.
□
§
UNIT ELASTIC if % change in Price = % change in Quantity Demanded .
This is true if the price elasticity of demand is εD___ 1.
□
§
○
Perfectly Elastic
If any change in Price will make Quantity Demanded equals ZERO or INFINITY.
§
○
Perfectly Inelastic
If change in Price will have no effect on the Quantity Demanded
§
○
PRACTICE
Suppose the price elasticity of demand is 1.5 & the price increases by 2%. What
happens to quantity demanded?
§
○
Suppose the government wants to decrease the number of cars that use Fort
Duquesne Bridge by imposing a fee. The fee will be most effective at reducing
traffic congestion if the price elasticity of demand for using the bridge is:
Elastic
a.
Inelastic
b.
Unit Elastic
c.
Impossible to tell without more information
d.
§
Price Elasticity of Demand along Demand Curves
When we talk about a specific value for price elasticity of demand, we mean AT A
SPECIFIC PRICE.
○
For many demand curves, the price elasticity of demand varies along the demand
curve.
○
•
Demand & Total Revenue
Total Revenue
Price x Quantity
§
○
As price increases from $1 to $2, Total Revenue ___________ from ____ to ____
○
The area A is ___________________. The area C is ________________________.
○
•
As price increases from $5 to $6, Total Revenue ___________ from ____ to ____
○
The area A is ___________________. The area C is ________________________.
○
Price Elasticities of Demand
•
Real-World Estimated Price
Elasticities of Demand
Eggs
0.32
Milk
0.63
Soft Drinks
0.79
Gasoline (in the long run)
0.24
Housing
1.2
Restaurant Meals
2.3
Airline Travel (Leisure)
1.5
Foreign Travel
4.1
Cross-Price Elasticity of Demand
Between Goods X and Y (εX,Y)
○
The cross-price elasticity of demand measures the responsiveness of Quantity
Demanded to Change in Price of ANOTHER GOOD.
○
Equation
○
•
εX,Y =
§
Interpretation
If εX,Y < 0, the goods are ______________.
§
If εX,Y > 0, the goods are ______________.
§
If εX,Y = 0, the goods are ______________.
§
○
Income Elasticity of Demand (εI)
The income elasticity of demand measures the responsiveness of Quantity Demanded
to Change in Income.
○
Equation
○
•
εI=
§
Interpretation
If εI< 0, the goods are ______________.
§
If εI> 0, the goods are ______________.
§
If εI> 1, the goods are ______________.
§
○
Price Elasticity of Supply (εS)
Measures how quantity supplied responds to change in price
○
Equation
○
εS=
§
We say that supply is:
ELASTIC if small change in Price --> big change in Quantity Supplied.
This is true if the price elasticity of supply is εS___ 1.
□
§
INELASTIC if big change in Price --> small change in Quantity Supplied.
This is true if the price elasticity of supply is εS___ 1.
□
§
UNIT ELASTIC if % change in Price = % change in Quantity Supplied.
This is true if the price elasticity of supply is εS___ 1.
□
§
○
Perfectly Elastic
If any change in Price will make Quantity Supplied equals ZERO or INFINITY.
§
○
Perfectly Inelastic
If change in Price will have no effect on the Quantity Supplied
§
○
•
Factors that affect Price Elasticity of Supply
Availability of Inputs
More inputs ---> _________ elastic
□
§
Time
More time ---> _________ elastic
□
§
○
Practice Problems
If a price decreased from $60 to $40 causes quantity demand to increase from 6 to
12, what happens to total revenue? Using what you know about price elasticity of
demand and total revenue. Is demand elastic, inelastic, or unit elastic?
○
•
Suppose that 5% increase in the price of widgets leads to a 15% decrease in the
quantity of gadgets. What is the cross price elasticity of demand? Using this, what
can you conclude about widgets and gadgets?
○
The perfectly elastic demand curve is ____.
○
The perfectly inelastic demand curve is ____.
○
___ is relatively more elastic than ____.
○
TRICK: Think Efor elastic & Ifor inelastic.
Notice that A ____ C.
○
In the inelastic region of demand, an
increase in Price will ________ Total Revenue.
Why?
▪
○
% change in Quantity Demanded is _______
than % change in Price.
○
Thus, added revenue from increase in Price
is __________ the lost revenue from decrease
of Quantity Demanded.
○
Notice that A ____ C.
○
In the elastic region of demand, an increase
in Price will ________ Total Revenue.
Why?
▪
○
% change in Quantity Demanded is _______
than % change in Price.
○
Thus, added revenue from increase in Price
is __________ the lost revenue from decrease
of Quantity Demanded.
○
Many factors affect demand elasticity
Necessity vs Luxury
Necessity more _______
○
Luxury more _______
○
•
Availability of Close Substitutes
as number of substitutes
increase, more _________
○
•
Share of Income
As income share increases,
more ___________
○
•
Time Frame
As time increases, more
________
○
•
The perfectly elastic supply curve is ____.
○
The perfectly inelastic supply curve is ____.
○
___ is relatively more elastic than ____.
○
TRICK: Think Efor elastic & Ifor inelastic.
Chapter 7
Taxes
Common type of taxes seen by individuals include:
Income taxes
§
Social insurance taxes
§
Property taxes
§
Excise taxes (per unit tax on good or service)
This is what we are going to be focusing on
□
§
○
Using the tools we have learned to date, we will focus on analyzing the effects
on an excising tax. The main questions are
What happens to the market equilibrium?
§
What happens to the welfare?
§
Who actually pays the taxes?
§
○
•
When the Tax is Levied on the Supplier
Consider the market for Hotel Rooms
○
•
When the Tax is Levied on the Consumer
Consider the Market for Hotel Rooms
○
•
Effect on Welfare
Before the tax
Consumer Surplus =
§
Producer Surplus =
§
Total Surplus =
§
○
•
Taxes and Elasticity
The burden of an excise tax mainly falls on more inelastic side of the market
○
Example of $2 tax when demand is relatively more _______ than supply
○
Burden
For Demand =
§
For Supply =
§
○
•
Example of $2 tax when demand is relatively more _______ than supply
○
Burden
For Demand =
§
For Supply =
§
○
Elasticity and Deadweight Loss of a Tax
Taxes create deadweight loss because they affect the mutually beneficial
trades
○
As demand and/or supply become more inelastic, DWL from, taxes _______
○
•
Q* = P* =
Suppose the government decided to
charge SUPPLIERS a $40 per room
tax.
○
Effective price for suppliers is P-$40
so supply curve shifts up by the
amount of tax to reflect this.
○
Q*tax = P*tax =
Buyers pay ____, Sellers receive ____
○
Thus, the effect of tax
On suppliers is ______
○
On buyers is ______
○
○
Q* = P* =
Suppose the government decided to
charge CONSUMERS a $40 per room
tax.
○
Buyers pay P+$40
○
Thus, the demand curve shifts down
by $40 to reflect this.
○
Q*tax = P*tax =
Buyers pay ____, Sellers receive ____
○
Thus, the effect of tax
On suppliers is ______
○
On buyers is ______
○
○
Suppose the government decided to
charge a $40 per room tax (doesn't
matter who is charged the tax!)
○
CStax =
○
PStax =
○
Govt. Revenue =
○
TStax = CStax + PStax + GR =
○
DWL =
○
Lecture 3
Wednesday,+May+23,+2018
2:19+PM
Document Summary
A unit free measurement of responsiveness to changes in prices or income. Gives us the tools necessary to make quantitative statements about the effects of a price or income change. Because it is unit free, elasticity makes it easier to compare different goods. Can also be useful for firms and governments when setting prices and implementing policies. Suppose good x"s price fell from to and the quantity demanded increased from 80k to 100k units. Good y"s price increased from to and the quantity demanded decreased from 75k to 70k. Measures how quantity demanded responds to change in price. Suppose that a price increase in milkshakes from to causes the quantity demanded to fall from 110k to 90k. Use the midpoint method to calculate the elasticity of demand. Elastic if small change in price --> big change in quantity demanded. Inelastic if big change in price --> small change in quantity demanded.
