ECON1101 Chapter Notes - Chapter 4: Australian Wine, Substitute Good, Demand Curve

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Chapter 4 - Subtleties of the supply and demand model: Price ﬂoors, ceilings and elasticity

Price ceiling - a maximum price imposed buy the government when it feels that the equilibrium

price is “too high”

Price ﬂoor - a minimum price imposed by the government when it feels that the equilibrium price is

“too low”

Elasticity measures how sensitive the quantity of a good that people demand or ﬁrms supply is to

the price of the good.

Price ceilings and Price ﬂoors:

Price control: a govt. law or regulation that sets or limits the price to be charged for a particular

good.

Price ceiling: a govt. price control that sets the maximum allowable price for a good. (Set to help

consumers)

Price ﬂoor: a govt. price control that sets the minimum allowable price for a good. (Set to help

suppliers)

Rent control: a govt. price control that sets the minimum allowable rent on a house or apartment

Side effects of price ceilings:

Price ceilings can have harmful side effects, that actually end up hurting consumers the most.

Where a shortage is likely to result, where sellers are unwilling to supply as much at a lower price,

and demand exceeds supply.

Dealing with persistent shortages:

• Ration coupons (used during WW2)

• Long waiting lines (typical in command economies)

• Black markets

• Another effect of price ceilings is a reduction in the quality of the good sold. By lowering the

quality of the good, the producer can reduce the costs of producing.

Side effects of price ﬂoors:

Price ceilings can have harmful side effects, If the price ﬂoor that the government imposes exceeds

the equilibrium price, then a surplus will occur. Meaning sellers are willing to sell more output then

buys want to buy.

Dealing with persistent shortages:

• Government might have to buy the surpluses this costs taxpayers money

• Government might try to reduce production, but leaving land idle or destroying crops is very

inefﬁcient.

• Higher prices raise costs for consumers

Elasticity of demand:

Deﬁning the price elasticity of demand:

Price elasticity of demand: the percentage change in quantity demanded of a good divided by the

percentage change in the price of that good.

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When price elasticity of demand is high, the quantity of a good demanded changes by a large

amount when the price changes. When the price elasticity is low, the quantity demanded changes

by only a small amount when the price changes.

Price elasticity of demand = % change in quantity demanded (divided by) % change in price.

Ignore any negative sings in the price elastic of demand. eg. price elastic of petrol is said to be 0.2,

meaning if petrol prices increase by 10% the quantity demanded will fall by 2% (0.2 x 10).

All other factors that affect demand are held constant when we compute the price elasticity of

demand. Knowing the elasticity of demand enables us to determine how much the quantity

demanded changes when the price changes.

The size of the elasticity: High vs low:

REVIEW:

• The price elasticity is a number that tells us how much the quantity demanded changes as the

price changes.

Working with demand elasticities:

e(d) repress the price elasticity of demand -

e(d) = change in quantity demanded (divided by) quantity demanded

(divided by)

change in price (divided by) price

The elasticity equals the percentage change the quantity demanded dividend by the perchance

change in the price. Ignoring any negative signs.

eg Australian wine fell by 8% and quantity demanded increased by 12% = 12/8 = 1.5

e.g. season prices rise form $50 to $60, which results in the demand for season ticket passes to

fall from 2000 to 1800. The price elastic for the tickets 200/2000 / 10/50 = 0.1/0.2 = 0.5

The advantage of a unit free measure:

unit free measure: a measure the does not depend on a unit of measurement.

The price elasticity of demand does not depend on units, it is a unit free measure because it use

percentage change. Thus it provides a good way to compare price sensitivity of the demand for a

range of different goods. Elasticity allows us to compare the price sensitivity of different goods by

looking at the ratios of percentage changes.

Elasticity vs Slope:

Elasticity of the demand curve is not the same as the slope of the demand curve.

The slope is the change in the y variable over the change in the x variable, where the slope is

deﬁned by the cage in the price dived by the change in the quantity.

Elasticity on the other hand is a unit free measure.

Calculating the elasticity with a midpoint formula:

To calculate the elasticity we ﬁnd the percentage change in the quantity demanded and divide by

the percentage change in the price.

To get a percentage change in the price or quantity we need to divide the change in price (delta p)

by the price or the change in the quantity demand (delta Q) divided by the quantity demanded.

Talking about elasticities:

We classify the demand curve by the size for the price elasticities of demand.

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Document Summary

Chapter 4 - subtleties of the supply and demand model: price oors, ceilings and elasticity. Price ceiling - a maximum price imposed buy the government when it feels that the equilibrium price is too high . Price oor - a minimum price imposed by the government when it feels that the equilibrium price is. Elasticity measures how sensitive the quantity of a good that people demand or rms supply is to the price of the good. Price control: a govt. law or regulation that sets or limits the price to be charged for a particular good. Price ceiling: a govt. price control that sets the maximum allowable price for a good. (set to help consumers) Price oor: a govt. price control that sets the minimum allowable price for a good. (set to help suppliers) Rent control: a govt. price control that sets the minimum allowable rent on a house or apartment.

Related Questions

1.) An excise tax on a good typically reduces the net price received by the seller. (TRUE/FALSE)

2.) The burden of an excise tax on gasoline falls entirely on consumers of gasoline. (TRUE/FALSE)

3.) Rent controls are one of the few examples of a price floor in market economies. (TRUE/FALSE)

4.) Imposing a price ceiling below the equilibrium price of a good often leads to_____.

A) A greater supply of the good

B) A black market for the good

C) A rightward shift of the supply curve for the good.

D) A leftward shift of the demand curve for the good.

E) All of these

5.) Which of the following is true of price floors and ceilings?

A) Lead to the same price and quantity as in competitive market.

B) Lead to technical efficiency

C) Cause the demand curve to shift left

D) Usually result from government intervention

E) Cause the supply curve to shift right.

6.) Price ceilings often lead to black markets. (TRUE/FALSE)

7.) When minimum wage is above the equilibrium wage what occurs?

A) There will be a shortage of labor

B) There will be no effect on the number of people employed

C) There will be an increase in unemployment rate

D) There will be a decrease in unemployment rate

8.) An excise tax on a good typically reduces the price paid by the consumer (TRUE/FALSE)

9.) If a price ceiling is below the equilibrium price is imposed on a market, it will cause the quantity demanded to rise and the quantity supplied to fall. (TRUE/FALSE)

10.) Price floors often lead to black markets. (TRUE/FALSE)

11.) If an excise tax is imposed on restaurant meals what occurs?

A) Fewer meals will be produced and sold

B) More meals will be produced and sold

C) Market price of the meals will fall

D) Government tax revenue will fall.

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Consider the demand and supply for used science textbooks. Supposed that the used textbook market is competitive with supply given by P=10+.1Q and demand given by P=100-.08Q. Solve for the competitive market equilibrium price and quantity of used textbooks in this market. Determine the quantity of shortage or surplus that would occur if a price ceiling (maximum allowable price) of $35 was imposed on this market. Describe why the market fails to be efficient in the context of this ceiling and what market participants commonly do to overcome the inefficiency caused by official prices below the equilibrium market price. If the intention is to help low income students, compare the effects of the price ceiling to an alternative scheme of giving $25 purchase vouchers to low-income students. In your answer, consider the effect of the vouchers on the demand for textbooks.

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QUESTION 38

You are the president of the United States. In an attempt to make gasoline prices cheaper, you have imposed a binding price ceiling on gas. What would you expect your critics to say?

	a.	The binding price ceiling will cause firms to minimize their spending on the research and development of alternatives to gasoline.
	b.	The binding price ceiling will discourage individuals from using their personal automobile to commute to work or school.
	c.	The binding price ceiling will increase the likelihood that customers obtain needed gasoline on the black market.
	d.	The binding price ceiling will encourage oil companies to deplete the resource too quickly.
	e.	The binding price ceiling will cause firms to produce only gasoline of the highest quality.

1.05000 points

QUESTION 39

If a firm's long-run average total costs increase as it increases its scale of production, the firm is experiencing:

	a.	increasing returns from specialization.
	b.	diseconomies of scale.
	c.	economies of scale.
	d.	constant returns to scale.
	e.	diminishing marginal product.

1.05000 points

QUESTION 40

A(n) __________ in the elasticity of supply or demand in a market for a good that is taxed would tend to __________ tax revenue from that tax.

	a.	increase; increase
	b.	increase; have no effect on
	c.	decrease; have no effect on
	d.	decrease; decrease
	e.	increase; decrease

1.05000 points

QUESTION 41

The costs of a market activity paid for by an individual engaged in the market activity are:

	a.	external costs.
	b.	social costs.
	c.	common costs.
	d.	free-rider costs.
	e.	internal costs.

1.05000 points

QUESTION 42

Assume that the price of rubber increased at the same time that Michael Jordan, arguably the best NBA basketball player of all time, became famous. What do you expect to happen to the equilibrium price and equilibrium quantity of the basketball shoes that are promoted by Michael Jordan?

	a.	Equilibrium price will go down and equilibrium quantity will be indeterminate.
	b.	Equilibrium price will go up and equilibrium quantity will go down.
	c.	Equilibrium price will go up and equilibrium quantity will be indeterminate.
	d.	Equilibrium price will go down and equilibrium quantity will go up.
	e.	Equilibrium price will go up and equilibrium quantity will go up.

1.05000 points

QUESTION 43

The minimum wage law is an example of a:

	a.	price floor.
	b.	law that sets the minimum number of hours that an employee must work for wages during the week.
	c.	law that allows individual employers and employees to make free decisions.
	d.	law that requires quantity demanded to equal quantity supplied.
	e.	price ceiling.

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ECON1101 Chapter Notes - Chapter 4: Australian Wine, Substitute Good, Demand Curve

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