WELCOME TO SEMINAR 4

June 8, Wed. 9-10 pm ET

BU224-01 MICROECONOMICSINSTRUCTOR: PAUL CHOI, PH.D.

READING: INTRODUCTION

The Market Strikes Back & Elasticity • In this unit, we begin to examine what happens

when governments try to control prices in a competitive market, keeping the price in a market either below its equilibrium level – a price ceiling such as rent control – or above – a price floor such as the minimum wage paid to workers in many countries.

You will also learn about elasticity; elasticity of demand and elasticity of supply. Elasticity measures how responsive consumers and firms are to changes in the market, such as market price.

(Krugman and Wells, 2009).

READING: CHAPTER 5

• Chapter 5 continues to explore how competitive markets operate by looking at the ways the government might intervene in markets to protect consumers, protect producers, or raise revenue. Rather than letting markets find their own equilibrium prices and output, the government may intervene in markets by imposing price ceilings, price floors, quotas, or taxes. Whenever the government does intervene in markets, some inefficiency or cost results.

READING: CHAPTER 6

• Chapter 6 continues our exploration of supply and demand by examining the degree to which quantity demanded responds to changes in the price of the good, income, and the prices of other goods, as well as how quantity supplied responds to the price of the good. The degree of responsiveness is known as elasticity. We also investigate the role of price elasticities in determining who actually pays a tax.

PRICE CONTROL: PRICE CEILINGS

THE EFFECTS OF PRICE CEILINGS: • Government-imposed price controls

that require prices to be no higher than a certain level are price ceilings. If a government sets a price ceiling below the market price, then at the ceiling price the quantity of the good demanded will exceed the quantity supplied. There will be a shortage of the good at the ceiling price.

PRICE CONTROL: PRICE FLOORS

THE EFFECTS OF PRICE FLOORS: • Government-mandated price controls

that require prices to be no lower than a certain level are price floors. If the government sets a price floor above the market price, then at the floor price the quantity of the good supplied will exceed the quantity demanded. There will be a surplus of the good at the floor price.

QUANTITY CONTROL

• GOVERNMENT-IMPOSED RESTRICTIONS ON MARKET QUANITITIES:

• Quantity restrictions can take the form of outright government bans on the sale of certain goods, such as human organs or various psychoactive drugs. They can arise from licensing requirements that limit the number of producers and thereby restrict the amount supplied of a good or service.

PRICE ELASTICITY

PRICE ELASTICITY: • Price Elasticity of Demand: The

responsiveness of the quantity demanded of a commodity to changes in its price; defined as the percentage change in quantity demanded divided by the percentage change in price.

Ep = percentage change in quantity demanded/percentage change in price.

• Calculating Elasticity: Ep = ∆Q/[(Q1 + Q2)/2] ÷ ∆P/[(P1 + P2)/2]

PRICE ELASTICITY

PRICE ELASTICITY RANGES: - Elastic demand: - Unit elasticity of demand: - Inelastic demand: • Extreme Elasticities: - Perfectly inelastic demand: - Perfectly elastic demand: ELASTICITY AND TOTAL REVENUES: • Labeling Elasticity: - Graphic Presentation: - The Elasticity-Revenue Relationship:

PRICE ELASTICITY

DETERMINANTS OF THE PRICE ELASTICITY OF DEMAND:

• Existence of Substitutes: • Share of Budget: • Time for Adjustment: - Short-Run versus Long-Run Adjustments: - Demand Elasticity in the Short Run and in the Long Run: - How to Define the Short Run and the Long Run:

CROSS PRICE ELASTICITY OF DEMAND: • Measuring the Cross Price Elasticity of Demand: Exy = ∆Qx/[(Qx1 + Qx2)/2] ÷ ∆Py/[(Py1 + Py2)/2]

PRICE ELASTICITY INCOME ELASTICITY OF DEMAND: • Measuring the Income Elasticity of Demand: Ei = percentage change in demand ÷ percentage change in

income • Calculating the Income Elasticity of Demand:

PRICE ELASTICITY OF SUPPLY: Es = percentage change in quantity supplied ÷ percentage

change in price • Classifying Supply Elasticities: - Perfectly elastic supply: - Perfectly inelastic supply: • Price Elasticity of Supply and Length of Time for

Adjustment:

PRICE ELASTICITY INCOME ELASTICITY OF DEMAND: • Measuring the Income Elasticity of Demand: Ei = percentage change in demand ÷ percentage change in

income • Calculating the Income Elasticity of Demand:

PRICE ELASTICITY OF SUPPLY: Es = percentage change in quantity supplied ÷ percentage

change in price • Classifying Supply Elasticities: - Perfectly elastic supply: - Perfectly inelastic supply: • Price Elasticity of Supply and Length of Time for

Adjustment:

PRICE ELASTICITY

THE RELATIONSHIP BETWEEN THE PRICE ELASTICITY OF DEMAND AND TOTAL REVENUES:

• Demand is elastic when the price elasticity of demand exceeds 1, and over the elastic range of a demand curve, an increase in price reduces total revenues.

• Demand is inelastic when the price elasticity of demand is less than 1, and over this range of a demand curve, an increase in price raises total revenues.

• Finally, demand is unit-elastic when the price elasticity of demand equals 1, and over this range of a demand curve, an increase in price does not affect total revenues.

PRICE ELASTICITY

PRICE ELASTICITY AND TOTAL REVENUE

(The above graph is from Wikipedia.com.)

PRICE ELASTICITY

DISCUSSION BOARD

Discussion Board Requirement: • Students are to post a minimum of

three posts per discussion question. One initial response and two replies to their classmates.

• Posting on a minimum of three different days, for example: Wednesday, Friday and Monday.

• The first post must be made by Saturday.

DISCUSSION BOARD

Discussion Board Topic: Critically analyze the pros and cons of

putting a price ceiling on prescription medicine. Make sure to use concepts from both chapters seen this unit such as government intervention, inefficiencies, price elasticity, etc. in your answer.

ASSIGNMENT: OUTLINE OF RESEARCH PAPER

• In Word, write the outline of your Research paper. You will need to provide a working title, your thesis statement, three major points you will treat in your paper, and two sources per point.

• Submit your outline in the dropbox.

ASSIGNMENT: HOMEWORK – UNIT 4

• Complete the following problem. Be sure to answer every part of the problem unless otherwise noted.

Chapter 5: Problem 4 on page 140 Chapter 6 : Problem 8 on page

165

ASSIGNMENT

• Directions for Submitting Your Assignment:

Before you complete your assignment, you should download the Template from the DocSharing and enter your answers directly in that document. Then save your work on your computer in a location and with a name that you will remember. When you are ready, you may submit on the Dropbox page.