Understanding Economics

2nd edition by Mark Lovewell and Khoa Nguyen

Chapter 3 Competitive Dynamics and Government
Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

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

Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Elastic and Inelastic Demand (b)
Figure 3.1 Page 56
Elastic Demand Curve for Ice Cream Cones
2.40 2.00 1.60 1.20 0.80 0.40 0 500 1000 D1
50%

Inelastic Demand Curve for Ice cream Cones
2.40 Price ($ per cone)

Price ($ per cone)

20%

20%

2.00 1.60 1.20 0.80 0.40 0 500 Quantity Demanded (cones) 1000
10%

D2

Quantity Demanded (cones)

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Perfectly Elastic and Perfectly Inelastic Demand (a)

Perfectly elastic demand means constant price and a horizontal demand curve Perfectly inelastic demand means constant quantity demanded and a vertical demand curve

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60 D3 0 Quantity Demanded (tonnes) 0 1000 Quantity Demanded (litres) Copyright © 2002 by McGraw-Hill Ryerson Limited.Perfectly Elastic and Perfectly Inelastic Demand (b) Figure 3. All rights reserved.2 Page 57 Perfectly Elastic Demand Curve for Soybeans Price ($ per tonnes) Price ($ per tonnes) Perfectly Inelastic Demand Curve for Insulin D4 1. .

. All rights reserved.Total Revenue and the Price Elasticity of Demand    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 Copyright © 2002 by McGraw-Hill Ryerson Limited.

All rights reserved.3 Page 59 Demand Curve for Videos Price ($ to rent a video) 5 4 3 2 1 0 500 1000 1500 B C A D Quantity Demanded (videos rented each day) Copyright © 2002 by McGraw-Hill Ryerson Limited.Revenue Changes with Elastic Demand Figure 3. .

4 Page 59 Demand Curve for Amusement Park Rides Price ($ per ride) 5 4 3 2 1 0 2000 F 4000 6000 8000 G E D 10 000 Quantity Demanded (riders each day) Copyright © 2002 by McGraw-Hill Ryerson Limited. . All rights reserved.Revenue Changes with Inelastic Demand Figure 3.

Total Revenue and the Price Elasticity of Demand (c) Figure 3. . All rights reserved.5 Page 60 Demand Elasticity and Changes in Total Revenue Price Change Elastic Demand up down up down up down Change in Total Revenue down up up down unchanged unchanged Inelastic Demand Unit-Elastic Demand Copyright © 2002 by McGraw-Hill Ryerson Limited.

. All rights reserved.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) Copyright © 2002 by McGraw-Hill Ryerson Limited.

In mathematical terms: ed = ΔQd ÷ average Qd Δprice ÷ average price Copyright © 2002 by McGraw-Hill Ryerson Limited.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. . All rights reserved.

giving a small ed. At high prices. Copyright © 2002 by McGraw-Hill Ryerson Limited. the change in quantity demanded (price) is relatively large (small). giving a large ed.Elasticity and a Linear Demand Curve (a)    A linear demand curve has a different price elasticity (ed) at every point. At low prices. All rights reserved. . the change in quantity demand (price) is relatively small (large).

00 0.43 0.11 5 Quantity Demanded Price ($ per soda) ed > 1 4 3 2 ed < 1 1 ed = 1 0 1 2 3 4 5 Quantity Demanded (millions of sodas) Copyright © 2002 by McGraw-Hill Ryerson Limited.Elasticity and a Linear Demand Curve (b) Figure 3.33 1. . All rights reserved.6 Page 62 Market Demand and Supply Curves for Milk Market Demand Schedules for Sodas Price Elasticity of Demand ($ per (ed) soda) (millions of sodas) Price 5 4 3 2 1 0 0 1 2 3 4 5 9.00 2.

All rights reserved.Income Elasticity   Income elasticity (ei) is the responsiveness of a product’s quantity demanded to changes in consumer income. . In mathematical terms: ei = ΔQd ÷ average Qd ΔI ÷ average I Copyright © 2002 by McGraw-Hill Ryerson Limited.

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) In mathematical terms: exy = ΔQd ÷ average Qd ΔPy ÷ average Py Copyright © 2002 by McGraw-Hill Ryerson Limited. . All rights reserved.

.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 Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

7. Page 64 Elastic Supply Curve for Tomatos Price ($ per kilogram) Price ($ per kilogram) 4 S1 3 50% Inelastic Supply Curve For Tomatos 4 S1 50% 3 2 1 0 20% 2 1 0 500 100% 1000 100 000 120 000 Quantity Supplied (kilograms per year) Quantity Supplied (kilograms per year) Copyright © 2002 by McGraw-Hill Ryerson Limited.Elastic and Inelastic Supply Figure 3. . All rights reserved.

Perfectly Elastic and Perfectly Inelastic Supply   Perfectly elastic supply means constant price and a horizontal supply curve Perfectly inelastic supply means constant quantity supplied and a vertical supply curve Copyright © 2002 by McGraw-Hill Ryerson Limited. . All rights reserved.

All rights reserved.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 constantcost industry and very elastic for an increasing-cost industry in the long run Copyright © 2002 by McGraw-Hill Ryerson Limited. .

All rights reserved. .50 2.00 Short-Run Supply Elasticity For Strawberries S2 0 750 000 Quantity Supplied (kilograms per month) 0 9 11 Quantity Supplied (millions kilograms per year) Copyright © 2002 by McGraw-Hill Ryerson Limited.8. Page 65 Immediate-Run Supply Elasticity for Strawberries Price ($ per kilogram) S1 Price ($ per kilograms) 2.Time and the Price Elasticity of Supply (b) Figure 3.

Therefore the long-run supply curve for a constant-cost industry is perfectly elastic. . As new businesses enter the industry in the long run due to a higher price of strawberries. All rights reserved. Copyright © 2002 by McGraw-Hill Ryerson Limited. this price is gradually pushed back down to its original level.Time and the Price Elasticity of Supply (c)  If strawberries are produced in a constant-cost industry:    A higher price of strawberries raises production but not resource prices.

this price is gradually pushed back down to its lowest possible level. . Copyright © 2002 by McGraw-Hill Ryerson Limited. Therefore the long-run supply curve for an increasing-cost industry is very elastic. All rights reserved.Time and the Price Elasticity of 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. but this level is higher than it was originally.

All rights reserved.Time and the Price Elasticity of Supply (d) Figure 3.8.00 Increasingcost Industry S3 Constantcost Industry 0 Quantity Supplied (millions kilograms per decade) Copyright © 2002 by McGraw-Hill Ryerson Limited. Page 65 Long-Run Supply Elasticity Price ($ per kilograms) S4 2. .

All rights reserved.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. . In mathematical terms: es = ΔQs ÷ average Qs Δprice ÷ average price Copyright © 2002 by McGraw-Hill Ryerson Limited.

All rights reserved.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 Copyright © 2002 by McGraw-Hill Ryerson Limited. .

All rights reserved. .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 Copyright © 2002 by McGraw-Hill Ryerson Limited.

Reasons for Price Supports Figure 3. . All rights reserved.9. page 68 Market Demand and Supply Curves for Wheat Market Demand and Supply Schedules for Wheat Price ($ per tonne) 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 140 b 120 100 80 60 40 20 0 D a S1 S0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Quantity (millions of tonnes per year) Copyright © 2002 by McGraw-Hill Ryerson Limited.

70 A price floor creates a surplus. D Quantity (millions of litres per year) Copyright © 2002 by McGraw-Hill Ryerson Limited.10 .10 .Effects of Price Supports Figure 3. All rights reserved.90 Quantity Quantity Demanded Supplied (D) (S) (millions of litres) 59 60 61 62 60 58 0 58 59 60 61 62 surplus S Price ($ per litre) 1.11.90 . page 70 Market Demand and Supply Curves for Milk Market Demand and Supply Schedules for Milk Price ($ per litre) 1.30 1. .30 1.

All rights reserved.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 Copyright © 2002 by McGraw-Hill Ryerson Limited. .

Effects of Rent Controls Figure 3.11. shortage D Quantity (units rented per month) Copyright © 2002 by McGraw-Hill Ryerson Limited. page 70 Market Demand and Supply Curves for Units Market Demand and Supply Schedules for Units S Price ($ per unit) Price ($ rent per month) 700 500 300 Quantity Quantity Demanded Supplied (D) (S) (units rented per month) 1700 2000 2300 2500 2000 1500 0 1500 2000 2300 2500 700 500 300 A price ceiling creates a shortage. . All rights reserved.

All rights reserved.Spillover Costs (a)  Spillover costs are the negative external effects of producing or consuming a product    adding these costs to private costs raises the supply curve the preferred outcome is at a lower quantity than in a perfectly competitive market government intervention (e.g. . an excise tax) can produce the preferred outcome Copyright © 2002 by McGraw-Hill Ryerson Limited.

00 0.50 2. Excise Tax b 2.50 1.50 0 1 2 3 4 5 6 7 8 Millions of Litres Copyright © 2002 by McGraw-Hill Ryerson Limited.Spillover Costs (b) Figure 3.00 1.00 1. page 72 Market Demand Curve for Strawberries Demand and Supply Schedules for Gasoline Price ($ per kg) Price ($ per kg) 2. All rights reserved.50 1.50 a S0 S1 Spillover Costs. .13.00 0.05 Quantity Quantity Demanded Supplied (D) (S0) (S1) (millions of litres) 4 5 6 7 8 8 7 6 5 4 6 5 4 3 2 D 2.

Spillover Benefits (a)  Spillover benefits are the positive external effects of producing or consuming a product    adding these benefits to private benefits raises the demand curve the preferred outcome is at a higher quantity than occurs in a perfectly competitive market government intervention (e. a consumer subsidy) can produce the preferred outcome Copyright © 2002 by McGraw-Hill Ryerson Limited.g. . All rights reserved.

14. All rights reserved. Student Subsidy D0 D1 0 8 9 10 11 12 13 14 Thousands of Students Copyright © 2002 by McGraw-Hill Ryerson Limited. . page 73 Demand and Supply Curves for an Engineering Education 6000 b Demand and Supply Schedules for an Engineering Education Tuition ($ per year) 6000 5000 4000 3000 2000 Enrollment Quantity Demanded Supplied (S0) (S1) (S) (thousands of students) 8 9 10 11 12 10 11 12 13 14 12 11 10 9 8 5000 Tuition ($ per year) 4000 3000 2000 S 1000 a Spillover Benefits.Spillover Benefits (b) Figure 3.

Getting More Than You Bargained For (a)  Alfred Marshall   was the first to establish the use of demand and supply curves devised the notion of consumer surplus which is the difference between marginal benefit and price for each unit of a product  The notion of consumer surplus applies both to individual consumer and market demand curves: Copyright © 2002 by McGraw-Hill Ryerson Limited. . All rights reserved.

All rights reserved. page 81 Consumer’s Demand Curve for Pizzas Consumer’s Demand Schedule for Pizzas Price ($ per pizza) Price ($ per pizza) 12 9 6 Quantity Demanded (D) (pizzas) 1 2 3 Total Benefit 12 9 A = $9 6 3 D B = $18 A+B = Total Benefit B = Total expenditure ($) 12 21 (12 + 9) 27 (12 + 9 + 6) 0 1 2 3 4 Quantity (pizzas per week) Copyright © 2002 by McGraw-Hill Ryerson Limited.Getting More Than You Bargained For (b) Figure A. .

000 2 4 Quantity (thousands of pizzas) Copyright © 2002 by McGraw-Hill Ryerson Limited.000 D B = $600. All rights reserved.Getting More Than You Bargained For (c) Figure B. page 82 Consumer’s Demand Curve for Pizzas Market Demand Schedule for Pizzas Price ($ per pizza) Price ($ per pizza) 16 11 6 Quantity Demanded (D) (thousands of pizzas) 0 50 100 16 14 12 10 8 6 4 2 0 A+B = Total Benefit B = Total Expenditures A = $500. .

. All rights reserved.The Economic Role of Government   Besides intervening in private markets. higher education subsidies. Government programs include payments to adults with children. welfare. and subsidized public housing. retirement funds for the elderly. free health care and schooling. Canadian governments have an independent role. unemployment insurance. Copyright © 2002 by McGraw-Hill Ryerson Limited.

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) Copyright © 2002 by McGraw-Hill Ryerson Limited. . All rights reserved.

All rights reserved. Copyright © 2002 by McGraw-Hill Ryerson Limited. .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).

1 Federal (1999-2000) ($ billions) Goods and services Transfers to Persons Businesses Provinces Debt Charges 63.9 5. .0 Provincial (1999 ($ billions) Goods and services Transfers to Persons Businesses Governments Debt charges 106.3 32.0 41.9 4.3 26. All rights reserved.9 23.0 1.5 0.7 23.6 20.Government Expenditures Figure A.5 198.2 3.3 11.5 157.8 9.1 27.3 3.5 Copyright © 2002 by McGraw-Hill Ryerson Limited.8 73. Page 85 Federal (1999-2000) ($ billions) Transfers to persons Benefits to the elderly Employment insurance benefits Transfers to other levels of government Subsidies and other transfers Crown Corporations Defence Government operations Debt charges 23.

Taxation (a)  Canadian governments use five main types of taxation:   Personal income taxes are levied by both federal and provincial governments. and 29%). Copyright © 2002 by McGraw-Hill Ryerson Limited. 26%. and are based on four marginal federal tax rates (16%. Sales taxes are levied by both federal and provincial governments. 22%. . All rights reserved. and are charged as a percentage of price on a wide range of products.

. Corporate income taxes are paid by corporations to both federal and provincial governments as a percentage of annual profits.Taxation (b)    Excise taxes are levied by both federal and provincial governments. All rights reserved. Property taxes are charged by local governments on buildings and land. and are usually charged as a dollar amount per unit of quantity on particular products. Copyright © 2002 by McGraw-Hill Ryerson Limited.

Page 86 Percent of Gross Domestic Product Personal income taxes Sales and excise taxes Property taxes Corporate income taxes Miscellaneous taxes 14.2 10. .5 3.4 8.5 3.Tax Revenues for All Levels of Government Figure B.6 29.4 Percent of Total Taxes 38.1 100.7 9.2 14.3 5.9 37. All rights reserved.0 Copyright © 2002 by McGraw-Hill Ryerson Limited.

.Government Taxes and the Canadian Economy Figure C. Page 87 40 Taxes as a Percentage Of GDP (%) 30 20 10 0 1926 1930 Local Provincial Federal 1940 1950 1960 Year 1970 1980 1990 2000 Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

Critics argue that taxes and some spending programs reduce productive activity.Debates over Government’s Role (a)    Taxes have increased significantly as a proportion of the total Canadian economy over the past few decades. Critics also contend that many government programs are inequitable. and hampered by high administrative problems. All rights reserved. . Copyright © 2002 by McGraw-Hill Ryerson Limited.

.Debates Over Government’s Role (b)  Supporters of government admit that public spending and taxation are not as effective as they could be. given that private markets are also subject to a variety of flaws. But they argue that these problems need to be seen in perspective. Copyright © 2002 by McGraw-Hill Ryerson Limited. All rights reserved.

All rights reserved.Understanding Economics 2nd edition by Mark Lovewell Chapter 3 The End Copyright © 2002 by McGraw-Hill Ryerson Limited. .

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