ECON 300 PPT CH - 03

Understanding Economics
6th edition
by Mark Lovewell
Copyright 2012 by McGraw-Hill Ryerson

Limited. All rights reserved.
6th edition
by Mark Lovewell
Chapter 3
Competitive Dynamics and
Government
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.
Learning Objectives
After this chapter, you will be able to:
1. comprehend price elasticity of demand, its
relation to other demand elasticities, and its

impact on sellers revenues
2. understand the price elasticity of supply and the
links between production periods and supply
3. identify how price elasticities of demand and
supply determine the impact of an excise tax on
consumers and producers
4. explain how governments use price controls to
override the invisible hand of competition
Elastic and Inelastic Demand (a)
Price elasticity of demand shows how

responsive consumers are to price changes.
elastic demand means % change in quantity
demanded is more than % change in price

inelastic demand means % change in quantity
demanded is less than % change in price
unit-elastic demand means % change in quantity
demand equals % change in price

Elastic and Inelastic

Demand (b)
Figure 3.1 Page 61
2.40
2.00
Inelastic Demand Curve

for Ice cream Cones
2.40
20%
1.60
D1
50%
1.20
0.80
0.40
0
500
1000
Quantity Demanded
(cones per winter month)
Price ($ per cone)
Price ($ per cone)
Elastic Demand Curve

for Ice Cream Cones
20%
2.00
D2
1.60
10%
1.20
0.80
0.40
0
500
1000
Quantity Demanded
(cones per summer month)

1800 2000
Perfectly Elastic and Perfectly

Inelastic Demand (a)
Perfectly elastic demand means a constant
price and a horizontal demand curve.
Perfectly inelastic demand means a constant
quantity demanded and a vertical demand
curve.

Perfectly Elastic and Perfectly Inelastic Demand (b)

Figure 3.2 Page 62
Perfectly Inelastic
Demand Curve
for Insulin
D3
1.60
D4
Price ($ per tonnes)
Price ($ per tonnes)
Perfectly Elastic
Demand Curve
for Soybeans
0
Quantity Demanded
(tonnes)

1000
Quantity Demanded
(litres)
Total Revenue and the Price Elasticity

of Demand (a)
A price change causes total revenue to
change in the opposite direction when
demand is elastic.
A price change causes total revenue to
change in the same direction when demand is
inelastic.
A price change does not affect total revenue
when demand is unit-elastic.

Revenue Changes with Elastic

Demand
Figure 3.3 Page 63
Price ($ to rent a DVD)
Demand Curve for DVDs
5
4
3
2
D
B
1
0
500
1000
1500
Quantity Demanded (DVDs rented each day)

Revenue Changes with Inelastic

Demand
Figure 3.4 Page 64
Price ($ per ride)
Demand Curve for Amusement Park Rides
5
4
3
1
0
2000
4000
G
6000
8000
10 000
Quantity Demanded (riders each day)

Total Revenue and the Price Elasticity of Demand (b)

Figure 3.5 Page 64
Demand Elasticity and Changes in Total Revenue

Price
Change
Change in
Total Revenue
Elastic Demand
up
down
down
up
Inelastic Demand
up
down
up
down
Unit-Elastic Demand
up
down
unchanged
unchanged

Determinants of the Price Elasticity

of Demand
There are four determinants:

portion of consumer incomes (products with
smaller portions more inelastic)

access to substitutes (products with more
substitutes more elastic)
necessities versus luxuries (more inelastic for
necessities and more elastic for luxuries)
time (more elastic with the passage of time)

Calculating Price Elasticity of

Demand
A numerical value for price elasticity of
demand (ed) is found by taking the ratio of the

changes in quantity demanded and in price,
each divided by its average value.
In mathematical terms:
ed =
Qd average Qd
price average price

Elasticity and a Linear Demand

Curve (a)
A linear demand curve has a different price
elasticity (ed) at every point.

At high prices, the change in quantity
demanded (price) is relatively large (small)

relative to average quantity demanded
(price), giving a large ed.
At low prices, the change in quantity
demanded (price) is relatively small (large)

relative to average quantity demanded, giving
a small ed.
Elasticity and a Linear Demand

Curve (b)
Figure 3.6 Page 67
Market Demand Curve for Sodas
Market Demand Schedules

for Sodas
Price
Elasticity
($ per
of Demand
(ed)
soda) (millions of sodas)
5
4
3
2
1
0
Quantity
Demanded
0
1
2
3
4
5
9.00
2.33
1.00
0.43
0.11
Price ($ per soda)
Price
5
ed > 1
4
3
ed = 1
2
ed < 1
1
Quantity Demanded
(millions of sodas)
Income Elasticity
Income elasticity (ei) is the responsiveness of
a products quantity demanded to changes in

consumer income.
ei = Qd average Qd
I average I

Cross-Price Elasticity
Cross-price elasticity (ei) is the
responsiveness of the quantity demanded of

one product (x) to a change in price of
another (y).
exy = Qd average Qd
Py average Py

Elastic and Inelastic

Supply
Price elasticity of supply measures the

responsiveness of quantity supplied to price
changes.
Elastic supply means % change in quantity
supplied is more than % change in price.

Inelastic supply means % change in quantity
supplied is less than % change in price.

Elastic and Inelastic Supply

Figure 3.7, Page 70
Inelastic Supply Curve

For Tomatoes
S1
3
50%
2
100%
1
0
100 000
Price ($ per kilogram)
Elastic Supply Curve

for Tomatoes
120000
Quantity Supplied
(kilograms per year)

S2
3
50%
2
1
0
20%
100 000 120 000

Quantity Supplied
(kilograms per year)
Perfectly Elastic and Perfectly

Inelastic Supply
Perfectly elastic supply means a constant
price and a horizontal supply curve.
Perfectly inelastic supply means a constant
quantity supplied and a vertical supply curve.

Time and the Price Elasticity of

Supply (a)
Price elasticity of supply changes over three

production periods:
Supply is perfectly inelastic in the immediate
run.
Supply is either elastic or inelastic in the short
run.
Supply is perfectly elastic for a constant-cost
industry and very elastic for an increasing-cost
industry in the long run.

Time and the Price Elasticity of Supply (b)

Figure 3.8, Page 71 (continued in part (e))
S1
750 000
Short-Run
Supply Elasticity
For Strawberries
Price ($ per kilograms)
Immediate-Run
Supply Elasticity
for Strawberries
S2
2.50
2.00
Quantity Supplied
(kilograms per month)

11
Quantity Supplied
(millions of kilograms per year)

Supply (c)
If strawberries are produced in a constant-
cost industry:
A higher price of strawberries raises production
but not resource prices.

As new businesses enter the industry in the
long run due to a higher price of strawberries,
this price is gradually pushed back down to its
original level.
Therefore the long-run supply curve for a
constant-cost industry is perfectly elastic.

Supply (d)
If strawberries are produced in a increasing-
cost industry:
A higher price of strawberries raises production
and also resource prices.

As new businesses enter the industry in the
long run due to a higher price of strawberries,
this price is gradually pushed back down to its
lowest possible level, but this level is higher
than it was originally.
Therefore the long-run supply curve for an
increasing-cost industry is very elastic.

Supply (e)
Figure 3.8, Page 71 (continued from part (b))
Price ($ per kilograms)
Long-Run Supply Elasticity

S4
S3
2.00
Increasingcost Industry
0
Quantity Supplied
(millions of kilograms per decade)

Constantcost Industry
Calculating Price Elasticity of

Supply
A numerical value for price elasticity of supply
(es) is found by taking the ratio of the changes

in quantity supplied and in price, each divided
by its average value.
es =
Qs average Qs
price average price

Excise Taxes (a)

An excise tax is a tax on a particular product
expressed as a dollar amount per unit of

quantity.
Such a tax creates a new supply curve (S 1)
seen by consumers. It is vertically above the
initial supply curve (S0) seen by producers.
The reason for this difference is that the price
as seen by consumers is now higher than that

seen by producers.

Excise Taxes (b)

The after-tax price for consumers is found
where S1 crosses the demand curve. The aftertax equilibrium price for producers is the
corresponding price on S0.
The total tax paid by consumers is found by
multiplying their tax-induced price rise by aftertax quantity.

Similarly, the total tax paid by consumers is
found by multiplying their corresponding price
drop by after-tax quantity.
The Impact of an Excise

Tax
Figure 3.9, page 74
The Impact of an Excise Tax
Market Demand and Supply

Curves For Strawberries
4.00
Price
3.00
3.00
2.50
2.00
1.50
1.00
5
7
9
11
13
13
11
9
7
5
9
7
5
3
1
3.50
Price ($ per kg)
Quantity
Quantity
Demanded
Supplied
($ per
(D)
(S0) (S1)
tonne)
(millions of tonnes)
S1
b
a
2.50
S0
$1
2.00
1.50
1.00
0.50
0
11
13
Quantity (millions of kg per year)

15
The Effect of Elasticity

For a given supply curve, the more elastic the
demand curve the greater the proportion of

an excise tax paid by producers.
For a given demand curve, the more elastic
the supply curve the greater the proportion of
an excise tax paid by consumers.

Excise Taxes and Demand Elasticity

Figure 3.10, page 75
Elastic Demand
Inelastic Demand
S1
S1
S0
2.25
2.00
$1
c
B
1.25
2.75
Price ($ per kg)
Price ($ per kg)
$1
A
c
2.00
B
1.75
S0

Excise Taxes and Supply Elasticity

Elastic Supply
Inelastic Supply
S1
S0
Price ($ per kg)
2.75
2.00
1.75
$1
A
B
S0
c
d
D
Price ($ per kg)
S1
2.25
2.00
B
1.25
$1

Price Controls
A price floor is a minimum price set above the

equilibrium price.
It results in a surplus in the market.
A price ceiling is a maximum price set below

the equilibrium price.
It results in a shortage in the market.

Agricultural Price
Supports
Price supports for agricultural goods are an

example of a price floor.
They help overcome unstable agricultural
prices.
Farmers win from these supports.
Consumers and taxpayers lose from these
supports.

Reasons for Price

Supports

Curves for Wheat
140
Price
120
Quantity
Quantity
Demanded
Supplied
($ per
(D)
(S0)
(S1)
tonne)
(millions of tonnes)
$140
120
100
80
60
10
11
12
13
14
14
13
12
11
10
12
11
10
9
8
Price ($ per tonne)

Schedules for Wheat
S1
S0
100
80
60
40
20
0
2 3 4
9 10 11 12 13 14
Quantity (millions of tonnes per year)

Effects of Price
Supports
Market Demand and Supply Curves

for Milk

Schedules for Milk
Quantity Quantity
Demanded Supplied
(D)
(S)
(millions of litres)
$1.30
59
62
1.10
60
60
0.90
61
58
Price ($ per litre)
Price
($ per
litre)
surplus
S
1.30
1.10
.90
A price floor
creates
a surplus.
.70
58
60
61
59
Quantity
(millions of litres per year)
62
Rent Controls
Rent controls are an example of a price

ceiling.
They keep down prices of controlled rental
accommodation.
Some (especially middle-class) tenants win
from these controls.
Other (especially poorer) tenants lose from
these controls.

Effects of Rent Controls


Curves for Units

Schedules for Units
Price
($ rent
per
month)
Quantity
Quantity
Demanded
Supplied
(D)
(S)
(units rented per month)
$700
1700
2500
500
2000
2000
300
2300
1500
Price ($ per unit)
S
700
A price ceiling
creates
a shortage.
500
300
shortage
0
1500
2000 2300 2500
Quantity
(units rented per month)

Prophet of Capitalisms
Doom
According to Karl Marxs theory of

exploitation:
a products price is based on the amount of
labour that goes into producing it

capitalists cut costs by minimizing workers
wages and by maximizing the length of the
workday
capitalists keep any surplus value, which is the
excess of their revenues over their costs

Marxs Theory of Exploitation

Figure A, Page 87
Creation of Surplus Value
Creation of Surplus Value
$50 Wage
$30 Wage
Daily Wage
$50
$30
Materials and
machine wear
and tear (M)
$10
$10
Surplus Value (SV)
$20
$40
Total Value
$80
$80
Exploitation Rate
(SV/W)
Value produced ($ per day)
(when producing 2 shirts or 1 suit)

80
60
W = 30
W = 50
W = 10
40
20
M = 10
SV = 10
SV = 40
$50
$30
Daily Wage

For the Public Good (OLC)

Besides intervening in private markets,
Canadian governments have an independent

role.
Government programs include payments to
adults with children, retirement funds for the
elderly, unemployment insurance, welfare,
higher education subsidies, free health care
and schooling, and subsidized public housing.


Federal Spending
The main federal spending programs are:
transfer payments to seniors (the Seniors
Benefit)
tax credits to low-income parents (the Child Tax
Credit)
transfer payments to the unemployed
(Employment Insurance)
pensions (the Quebec and Canada Pension
Plans)


Provincial and Territorial
Spending
The responsibilities of provincial and territorial
governments include:
health care
subsidies for post-secondary education
welfare services
The federal government pays a portion of
these costs through the Canada Health and

Social Transfer (CHST).


Government Expenditures
Figure A
Federal (2009)
($ billions)
Goods and services
Transfers to
Persons
Businesses
Nonresidents
Provinces and local
Debt charges
Provincial (2009)
($ billions)
63.9
87.9
4.5
4.8
65.1
26.1
Goods and services

Transfers to
Persons
Businesses
Governments
Debt charges
253.1

214.
1
43.1
11.1
52.5
28.3
349.
2
Local (2009)
($ billions)
Goods and
services
Transfers to
Persons
Businesses
Provinces
Debt Charges
109.
1
4.0
2.2
0.1
3.5
118.
9

Taxation (a)
Canadian governments use five main types of
taxation:
Personal income taxes are levied by both
federal and provincial governments, and are

based on four marginal federal tax rates (15%,
22%, 26%, and 29%).
Sales taxes are levied by both federal and
provincial governments, and are charged as a
percentage of price on a wide range of
products.

Taxation (b)
Excise taxes are levied by both federal and
provincial governments, and are usually

charged as a dollar amount per unit of quantity
on particular products.
Property taxes are charged by local
governments on buildings and land.
Corporate income taxes are paid by
corporations to both federal and provincial
governments as a percentage of annual profits.


Tax Revenues for All Levels of Government (2009)
Figure B
Personal income
taxes
Sales and excise
taxes
Property taxes
Corporate income
taxes
Miscellaneous taxes
Percent of
Gross Domestic
Product
11.5
8.7
3.2
2.5
4.6
30.5

Percent of
Total Taxes
37.6
28.4
10.5
8.2
15.0
100.0

Taxes and the Canadian Economy
Figure C


Debates over Governments Role
(a)
Taxes have increased significantly as a
proportion of the total Canadian economy

over the past few decades.
Critics argue that taxes and some spending
programs reduce productive activity.
Critics also contend that many government
programs are inequitable, and hampered by
administrative problems.


Debates Over Governments Role
(b)
Supporters of government admit that public
spending and taxation are not as effective as

they could be. But they argue that these
problems need to be seen in perspective,
given that private markets are also subject to
a variety of flaws.

6th edition
by Mark Lovewell
Chapter 3
The End
Copyright 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

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Understanding Economics

Copyright 2012 by McGraw-Hill Ryerson

relation to other demand elasticities, and its

Elastic and Inelastic Demand (a)

Price elasticity of demand shows how

demanded is more than % change in price

Copyright 2012 by McGraw-Hill Ryerson

Elastic and Inelastic

Inelastic Demand Curve

Price ($ per cone)

Price ($ per cone)

Elastic Demand Curve

Copyright 2012 by McGraw-Hill Ryerson

Perfectly Elastic and Perfectly

Copyright 2012 by McGraw-Hill Ryerson

Perfectly Elastic and Perfectly Inelastic Demand (b)

Price ($ per tonnes)

Price ($ per tonnes)

Copyright 2012 by McGraw-Hill Ryerson

Total Revenue and the Price Elasticity

Copyright 2012 by McGraw-Hill Ryerson

Revenue Changes with Elastic

Price ($ to rent a DVD)

Demand Curve for DVDs

Quantity Demanded (DVDs rented each day)

Copyright 2012 by McGraw-Hill Ryerson

Revenue Changes with Inelastic

Price ($ per ride)

Demand Curve for Amusement Park Rides

Quantity Demanded (riders each day)

Copyright 2012 by McGraw-Hill Ryerson

Total Revenue and the Price Elasticity of Demand (b)

Demand Elasticity and Changes in Total Revenue

Copyright 2012 by McGraw-Hill Ryerson

Determinants of the Price Elasticity

There are four determinants:

smaller portions more inelastic)

Copyright 2012 by McGraw-Hill Ryerson

Calculating Price Elasticity of

demand (ed) is found by taking the ratio of the

Copyright 2012 by McGraw-Hill Ryerson

Elasticity and a Linear Demand

elasticity (ed) at every point.

demanded (price) is relatively large (small)

demanded (price) is relatively small (large)

Elasticity and a Linear Demand

Market Demand Curve for Sodas

Market Demand Schedules

Price ($ per soda)

a products quantity demanded to changes in

Copyright 2012 by McGraw-Hill Ryerson

responsiveness of the quantity demanded of

Copyright 2012 by McGraw-Hill Ryerson

Elastic and Inelastic

Price elasticity of supply measures the

supplied is more than % change in price.

Copyright 2012 by McGraw-Hill Ryerson

Elastic and Inelastic Supply

Inelastic Supply Curve

Price ($ per kilogram)

Price ($ per kilogram)

Elastic Supply Curve

Copyright 2012 by McGraw-Hill Ryerson