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SizeofChangesinMarketEquilibrium
Whatdeterminesthesizeofchangesinmarket
equilibrium?
ELASTICITY Sizeofchangeindemand(orsupply)
Thelargertheshiftindemand(orsupply),thelargertheeffect
onprice
Steepnessofthecurvethatdoesnotshift
Ifthesupplycurveshifts,thesteeperthedemandcurvethe
morethepricechangesandthelesstheamountboughtand
soldchanges
Steepnessreflectsresponsivenesstoprices
2-2
ChangesinEquilibriumforTwoExtremeSupplyCurves
ChangesinEquilibriumforTwoExtremeDemandCurves
2-3 2-4
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Steepnessofthedemandcurve
ElasticitiesofDemandandSupply
Ameasureoftheresponsivenessoftheamounts
P
demandedandsuppliedtochangesinprices
S Notthesameastheslopeofthesupplyordemand
S
curve
Slopeofthecurvedependsontheunitsusedto
measurethequantityofthegoodanditsprice
Elasticitydoesnotdependonunits(e.g.,gallons,
dozens,dollarsperpound)
Q
D2 D1
Elasticity Elasticity
Demand curves can come in different
shapes We know that quantity demanded depends on many
things
From very flat to very steep So we can ask a more general question.
Very flat demand curve: a small change in How sensitive is demand to change in any of the
price has a large effect on quantity relevant factors:
demanded - Own price
Very steep curve: even a large change in - Income
price does not affect quantity demanded too - Related prices
much - Etc.
Question: how sensitive is quantity
demanded to price changes?
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Elasticities
Two situations:
Consider the market demand for a commodity, q
Situation 1 2
Let it depend on a factor y (which might be its own
price, or the price of a related good, or income). Quantity q1 q2
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q p e = - [q/p]x[p/q],
e = - ----x---- = - (p/q)x(q/p).
p q q = q2 - q1 = 5
p = p2 - p1 = -1
1.Pointelasticitymeasures. 2.Arcelasticitymeasure.
e = - [q/p]x[p1/q1] To get rid of this ambiguity, take an average of the
= -(-5)x(10/100) = 5/10 = .5 values:
e = - [q/p]x[p2/q2]
q [(p2 + p1)/2]
= -(-5)x(9/105) = 9/21 = 3/7
= .42 e = - ---------------------------
p [(q2 + q1)/2]
small changes in price -> not much difference
between these two.
For larger changes, the differences become = - [q/p][(p2 + p1)/(q2 + q1)]
substantial.
= 5(19/205) = .46.
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P AStraightLineDemandCurve
Consider the straight-line
demand curve AB. What is e
A at the point C? Then price-elasticity at a point C on the demand
curve = (EB/CE)(CE/OE) = EB/OE
Note: [q/p] = EB/CE, = (BC/CA)
D C
p = CE, q = OE (by property of similar triangles).
PriceElasticityRegionsalong
aStraightLineDemandCurve If the percentage change in q > the
Observation percentage change in p, then e > 1, and
Price elasticity varies at we have elastic demand.
every point along a straight-
line demand curve
a/2 1
If the percentage change in q < the
percentage change in p, so that e < 1,
b/2 b demand is said to be inelastic.
Quantity
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PriceElasticityandthe
PriceElasticityandthe
SteepnessoftheDemandCurve
SteepnessoftheDemandCurve
What is the price elasticity of
demand when P = Rs.4?
12 12 Observation
If two demand curves have a
D1 4 1 1
D1 point in common, the steeper
4 12 2 curve must be less elastic with
6 D1
respect to price at that point
6 6
Price
Price
4 1
D2
4
4 2
4 6
D2 12 D2
4 6 12 4 6 12
Quantity Quantity
Priceelasticity Threespecialcases
If (inverse) demand curve is a horizontal straight line
Supposethatwehaveadifferentiabledemandfunction parallel to the quantity axis, then the price-elasticity
Q=Q(P). measure goes to infinity.
Thenelasticityatapoint(P*,Q*)onthedemand - demand is perfectly elastic.
curveis
E=(dQ/dP)(P*/Q*) If the (inverse) demand curve is a vertical straight line,
wheredQ/dPisevaluatedat(P*,Q*) then e = 0 and demand is said to be perfectly
Example:LetQ = p-a inelastic.
Then dQ/dP = (-a) p-a-1
E=[(-a) p-a-1][p/p-a] = a (independent of the point on An example of a demand curve that is iso-elastic (has
the demand curve) the same elasticity everywhere) is q = p-a.
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D D
Basic needs, minimum
requirements, absolute
necessities.
0 Q 0 D Q
Rangeofelasticities
0_______________1________________+
PerfectlyUnitPerfectly
InelasticElasticityElastic
DemandDemand
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S
50 dp < 0.
exy = (x/p)(p/x)
In the case of a normal good, em > 0, while for an
inferior good, it is < 0.
If this is positive, x and y are said to be substitutes
(Coke and Pepsi), while if this is negative, the
If 0 < em < 1, then the good is called a necessity,
commodities are said to be complements (tea and
otherwise it is a luxury. sugar).
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CalculatingthePrice
ElasticityofSupplyGraphically
Price Elasticity of Supply
Suppose that q now refers to quantity supplied. A 4 1212 4 1 S
Price
Since supply curves are upward-sloping, this B 5 15 15 5 1
expression will be non-negative no need to put a
negative sign in front of the expression
0 12 15
Quantity
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Wheatexportallowedtofreestoragespace
PriceSupport 3July2012
Anotherwayforthegovernmenttohelpthefarmersis
byhavingasupportprice,atwhichpricethe
governmentstandspreparedtobuyanyamount Facedwithaseverespaceconstraintinthecountrys
suppliedbythefarmers overflowinggranaries,thegovernmenttodaycleared
Overtime,thismayleadtothegrowthofbuffer exportoftwomilliontonsofwheatfromitsbuffer
stockthatisexpectedtoclearstoragespacefornew
stocks
crops.
Willperishifjuststockpiled
Somecanbeusedforemploymentgeneration ThiswasapprovedbytheCabinetCommitteeon
programmes,ormeetingfoodrequirementsinalean EconomicAffairs.Informedsourcessaidafterthe
year CCEA meetingthatexportwithafloorpriceof$228
(aboutRs12,400)perton.
Whattodowiththerest?
Atpresent,thegovernmentisgrapplingwiththe
problemofstoragecapacity. TAXES
India,theworldssecondlargestproducerofwheat,
hadharvestedarecord90.23milliontonsin201112 Governmentslevytaxestoraiserevenuefor
cropyear(JulyJune),leadingtoarecordprocurement publicprojects,topayforwagesandsalaries
ofnearly38milliontonssofarthisyear. inthepublicsector,topayinterestondebt,
Itsgodowns areoverflowingwitharecord82million etc..
tonsofriceandwheatagainstthestoringcapacityof
only64milliontons.
Theexportoftwomilliontonswouldinvolveanoutgo
ofRs 1,263crore.
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Taxes Taxes
Aspecifictax isafixedrupeeamountthat Instudyingtheeffectsoftaxesitsimportant
mustbepaidoneachunitboughtorpaid todistinguishbetweentheamounta
Anadvaloremtax isataxthatisstatedas consumerpaysforagoodandtheamounta
apercentageofthegoodsprice firmreceives
Theincidenceofataxindicateshow UsePb fortheamountaconsumerpays,Ps
muchofthetaxburdenisbornebyvarious fortheamountafirmreceives
marketparticipants IfthetaxisTperunit,thenPs =Pb T
15-49
TheBurdenofaTax EffectsofaSpecificTax
ConsidertheeffectofaspecifictaxofTrupeesper
literpaidbygasstationsontheirsalesofgasoline Shiftingthesupplycurveisonewayto
Graphically,therearethreewaystodeterminethe determineaspecifictaxseffects
taxseffect:
ShiftthesupplycurveupbyT Demandcurveremainsunchanged
ShiftthedemandcurvedownbyT Foranypricepaidbyconsumers,firms
Useawedgebetweentheamountsconsumers nowreceivelessthanwhenthereisnotax
payandfirmsreceive Wontbewillingtosupplyasmuchas
Allthreemethodsyieldthesameresults before
Makesnodifferencewhetherthetaxisleviedon SupplycurvewiththetaxisadistanceT
consumersorproducers
abovetheoriginalsupplycurve
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EffectsofaSpecificTax ShiftingtheSupply
EffectsofaSpecificTax Curve
Newequilibriumpricepaidby ST
cross Pb T
Amountboughtandsoldfalls Po
Ps = Pb - T
A
Pricepaidbyconsumersrises;price Decrease in
Firms Receipts
receivedbyfirmsfalls per Gallon
D
Inacompetitivemarkettheburdenofa QT Qo
taxissharedbyconsumersandfirms Gallons of Gas per Month
15-54
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EffectsofaSpecificTax Shiftingthe
DemandCurve
Lineardemandandsupply
LetQd =a bpb
andQs =c+dps
Also,ps=pb t
Equilibriumrequires
a bpb=c+dps
Thena
b(ps+t)=c+dps
Solvingfortheequilibriumpriceps*,weget
ps*=(a c bt)/(d+b)
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