Lecture 10. March 2009 Microeconomics Esther Kalkbrenner: What is our Program until the end of the semester?

Transcription

1 Lecture 10. March 2009 Microeconomics Esther Kalkbrenner: What is our Program until the end of the semester? Suly and Demand Familiar Concets Suly and Demand (Chater 2) Alying the Suly and Demand Model (Chater 3) Consumers Choice Firms Production And Costs Market Setting For Interaction Btw. Consumers and Firms Consumer Choice (Chater 4) Alying Consumer Theory (Chater 5) Firms and Production (Chater 6) Minimizing Costs (Chater 7) Cometitive Firms and Markets (Chater 8) Alying the Cometitive Model (Chater 9) Market Power and Market Structure Monooly (Chater 11) Pricing (Chater 12) Oligooly (Chater 13)

2 Lecture 10. March 2009 Microeconomics Esther Kalkbrenner: Last lecture: We identified the main ingredient for the demand-suly model demand curve suly curve cometitive market the setting that allows us to aly the demand-suly model We saw - combinations that make us move along either the demand or the suly curve (keeing other influencing factors such as of other goods, income, tastes, inut rices constant) We saw - combinations that cause a shift in either the demand or the suly curve (because one of the factors such as of other goods, income, tastes or inut rices have changed) Market Equilibrium Shocks to the Market Equilibrium (move from e1 to e2)

3 Lecture 10. March 2009 Microeconomics Esther Kalkbrenner: Starting uestion today: How can we aly the demand-suly model to determine by how much the equilibrium quantity and equilibrium rice changes ( quantitative change) if an underlying factor (e.g. Income or another factor that affects the demand or the suly curve) changes? Toics today: Shae of the demand and suly curve is imortant for equilibrium e.g. vertical demand curve differs in effects to a downward sloing demand curve Analyze the sensitivity of the quantity demanded to a rice change Analyze the sensitivity of the quantity sulied to a rice change Does the sensitivity differ deending if we think in the long run (LR) or in the short run (SR)? What effect has a tax on the equilibrium quantity and equilibrium rice?

4 Shaes of demand/suly curve: Examle suly/demand for ork: Downward sloing demand curve: What is the effect on equilibrium and? Horizontal demand curve consumers are very sensitive to changes in rices What is the effect on equilibrium and? Vertical demand curve consumers are not sensitive to changes in rices: What is the effect on equilibrium and?

5 Concet of sensitivity of quantity demanded to rice One measure for sensitivity elasticity the % change of one variable (the quantity demanded) to a given % change of another variable (rice) rice elasticity of demand (or elasticity of demand) Use the elasticity of demand to describe the shae of the demand curve How to calculate the elasticity of demand? ε d d Interretation? The Elasticity of Demand -0.3% If rice of ork increases by 1%, then the quantity demanded falls by less than 1% less than the rice change

6 Imortant Features of the Elasticity of Demand Different Forms of Demand Elasticity: elastic demand: the quantity demanded changes more than in roortion to a change in rice inelastic demand: the quantity demanded changes less than in roortion to a change in rice Imortant: Elasticity of demand varies along most linear demand curves Excetion: The secial tye of demand curve, the constant elasticity demand curve elasticity is the same at every oint along the demand curve Different demand elasticities: Price elasticity of demand THE elasticity of demand But there are also other demand elasticities that show how quantity demanded changes in resonse to other changes in variables Income Elasticity Cross Price Elasticity

7 Grahically: Elasticity of linear Demand Examle suly/demand for ork: If we have a downward-sloing linear demand curve then: Perfect elastic: - where the demand curve hits the vertical axis (y-axis) Unitary elastic: -1 where the demand curve hast it s midoint Perfectly elastic: 0 where the demand curve hits the horizontal axis (x-axis)

8 Extreme Cases for the shae of the demand curve: So far we looked at a downward sloing linear demand curve: a b Elasticity of demand: ε b Remember that the shae of the demand curve matters (beginning of lecture) Two extreme cases of demand curve: horizontal and vertical demand curve elasticity does not change along the demand curve This demand curve is called constant-elasticity demand curve

9 Secial Demand Curve: Constant Elasticity of Demand Constant elasticity demand curve means that elasticity is the same at every oint along the demand curve What is the functional form of a constant elasticity demand curve? ε A Three secial cases of constant elasticity demand curves: vertical demand curve: erfectly inelastic everywhere 0 e.g. essential good horizontal demand curve : erfectly elastic everywhere - e.g. erfect subsitutes combi of vertical and horizontal demand curve e.g. demand for insulin Constant Elasticity algebraical: d ε 1 ε 1 εa εa d A ε ε ε

10 Grahical Aroach: Constant Elasticity Demand Curves

11 Other Demand Elasticities: Income elasticity of demand: The % change in the quantity demanded because of a % change in income ξ Y Y d dy Y Cross-rice Elasticity: The % change of the quantity demanded of one good because of a % change in rice of another good 0 0 d d 0 0 Negative cross-rice elasticity: increase of rice less demand for this good shift of demand to the left Positive cross-rice elasticity: increase of rice higher demand for this good shift of demand to the right

12 Examle for the linear demand for ork: Linear demand for Pork: b + 3c + 2Y * 3.30, * 220 b 1 4, c 3, Y Price elasticity of Pork: ε d d 3.30 ( 20) Income elasticity of Pork: ξ d dy Y Y Cross elasticity between ork and beef: d d b b b

13 Elasticity of Suly η The Elasticity of Suly If rice of ork increases by 1%, then the quantity sulied changes by how many % oints? Imortant: Elasticity of Suly varies along most linear suly curves How to calculate the elasticity of suly?: If Suly curve is uward sloing then η > 0 η d d downward sloing then η < 0 Elastic Unitary elastic Inelastic if if if η > 1 η 1 η < 1

14 Grahical Aroach: Elasticity along the linear uward sloing Suly Curve

15 Examle for the linear suly for ork: Linear suly for Pork: * 3.30, * 220 Elasticity of Suly for Pork η d d Interretation: As the rice of ork increases by 1% the quantity sulied increases by nearly two thirds of 1%

16 Secial case of the suly curve (shae): So far we looked at a uward sloing linear suly curve: g + h Elasticity of suly: η h Two extreme cases of suly curve: horizontal and vertical suly curve : elasticity does not change along the suly curve This suly curve is called constant-elasticity suly curve Suly Curve vertical erfectly inelastic Whatever the rice, the firm sulies the quantity e.g. erishable goods Suly Curve horizontal erfectly elastic Only at rice * the firm sulies a otentially unlimited amount

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18 Effects of a tax on suly-demand equilibrium?: Imortant to know the effect of a tax for olicy makers: 1. What effect has it on equilibrium? 2. Who is affected by the tax (Consumers or Producers or both)? 3. Is the new equilibrium after introducing a tax different if consumers are assessed or roducers? We treat 2 different tyes of taxes: Ad-valorem Tax e.g. sales tax Secific or unit Tax e.g. tax is collected er unit of outut e.g. gasoline tax

19 Evaluate effects of a secific Tax in the Pork Market: Grahically: Incororate the concet of secific tax into the suly-demand model: Assume: Secific tax is assessed by firms at time of sale e.g. $1.05 er kg ork Consumer ays and Firm receives (-) and Government receives 1. uestion to answer: What is the effect on the ork market equilibrium?

20 Evaluate effects of a secific Tax in the Pork Market: Algebraically: Assume: Secific tax is assessed by firms at time of sale e.g. $1.05 er kg ork Consumer ays and Firm receives (-) and Government receives 1. uestion to answer: What is the effect on the ork market equilibrium? s ( τ ) D ( 1.5) In equilibrium Suly Demand: s D * 4$, * *

21 Evaluate effects of a secific Tax in the Pork Market: 2. uestion to answer: Who is bears the burden of the tax What is the incidence of the tax? Amount by which tax affects the equilibrium rice and quantity deends on the elascticities of suly and demand The government raises the tax from 0 to t The rice consumers ay changes by: Examle of the ork market use elasticity calculate before: ε 0.3 η 0.6 τ τ 1.05 η 0.6 τ (1.05) 0.70$ η ε 0.6 ( 0.3) τ τ 0 τ η τ η ε Tax Incidence on consumers: τ

22 Evaluate effects of a secific Tax in the Pork Market: 3. uestion: Does the equilibrium or the incidence of the tax deend on whether the tax is collected from roducers or consumers? Answer: No Tax Collected at Producers Tax Collected at Consumers S1 shifts u to S2 S D ( τ ) * 4 * 206 D1 shifts down to D2 S D ( + τ ) * 4 * 206

23 Evaluate effects of ad valorem Tax : Grahically: Secific tax Ad valorem tax on the rice of ork At any given rice, the ga between D and Da is In order to raise the same amount of tax as shifts D to Ds shifts D to Da τ 1.05 τ α α ad valorem tax needs to be α %