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Working with Supply and
Demand
© 2003 South-Western/Thomson Learning
Government Intervention in
Markets
•Price Ceilings
•Price Floors
•Taxes
Government Intervention
in Markets
Price Ceiling
A government-imposed
maximum price in a market
Price Ceiling
Price
per
Bottle
S
T
$4.00
E
3.00
2.00
R
V
D
Number
4,000 5,000 6,000 of Bottles of
Maple Syrup
Government Intervention
in Markets
When quantity supplied and quantity
demanded differ, whichever of the
two quantities is smaller, the short
side of the market will prevail.
Government Intervention
in Markets
•A price ceiling creates a shortage,
increasing the time and trouble
required to buy the good.
•While the price decreases, the
opportunity cost may rise.
Government Intervention in
Markets
Price Floor
A government-imposed minimum
price in a market
Price Floor
Price
per
Pound
S
$0.90
0.80
K
J
A
D
180 200 220
Millions
of Pounds
Government Intervention in
Markets
•Price floor creates an excess supply of a
good
•To maintain a price floor, government must
prevent excess supply from driving down the
market price
•In practice, government often does this by
purchasing the excess supply itself
Government Intervention
in Markets
Excise Tax
A tax on a specific good or
service.
Excise Tax
Price
per Unit
S
$1.50
.90
B
A
60
120
Quantity
Excise Tax
An excise tax shifts the market supply
curve upward by the amount of the tax.
For each quantity supplied, the new,
higher supply curve tells us firms’ gross
price, and the original, lower supply
curve tells us the net price.
Excise Tax
Price
per
Ticket
S'
$800
730
700
S
B
A
D
10 11.3
Tickets
(Millions
per Year)
Excise Tax
•An Excise tax on a good increases the
price paid by consumers, but decreases
the (net) price received by sellers.
•Both buyers and sellers bear part of
the burden of paying taxes.
Price Elasticity of Demand
•Calculating Price Elasticity of Demand
•Elasticity and Straight-line Demand Curves
•Elasticity and Total Expenditure
•Categorizing Goods by Elasticity
•Determinants of Elasticity
•Using Price Elasticity of Demand
Price Elasticity of Demand
•The sensitivity of quantity
demanded to price
•The percentage change in quantity
demanded caused by a 1 percent
change in price
%Q
ED 
%P
D
Price Elasticity of Demand
•A percentage change is usually
defined as the change in a variable
divided by the starting, or base,
value
•The base value is always midway
between the initial value and the
new value
Price Elasticity of Demand
Price
per
Laptop
$3,500
3,000
D
C
2,500
2,000
1,500
1,000
B
A
D
100,000 200,000 300,000 400,000 500,000 600,000
Quantity
of Laptops
Elasticity and Straight-Line
Demand Curves
•Elasticity of demand varies along a
straight-line demand curve.
•More specifically, demand becomes
more elastic as we move upward and
leftward.
Elasticity and Straight-Line
Demand Curves
Price
Since equal dollar
increases (vertical arrows)
are smaller and smaller
percentage increases . . .
3
2
. . . and since equal quantity
decreases (horizontal arrows)
are larger and larger
percentage decreases . . .
1
. . . demand becomes
more and more elastic
as we move leftward and
upward along a straight
line demand curve.
D
Quantity
Inelastic Demand
Inelastic Demand
A price elasticity of demand
between 0 and -1
Perfectly Inelastic Demand
Perfectly Inelastic Demand
A price elasticity of demand
equal to 0
Perfectly Elastic Demand
Elastic Demand
A price elasticity of demand
less than -1
Extreme Cases of Demand
(a)
(b)
Price
per
Unit
Price
per
Unit
D
$4
$4
3
Perfectly Inelastic
Demand
3
2
2
1
1
20
40
60
80
100
Perfectly Elastic
Demand
D
20
Quantity
40
60
80
100
Quantity
Perfectly Elastic Demand
Perfectly (Infinitely) Elastic
Demand
A price elasticity of demand
approaching minus infinity
Unitary Elastic Demand
Unitary Elastic Demand
A price elasticity of demand
equal to -1
Elasticity and Total
Expenditure
• If demand is price inelastic, then total
expenditure moves in the same direction as
price.
• If demand is elastic, total spending
moves in the opposite direction from price.
• If demand is unitary elastic, total
expenditure remains the same as price
changes.
Effects of Price Changes on
Expenditure
Where Demand is:
A price increase will:
A price decrease will:
inelastic (|ED| < 1)
unitary elastic (|ED| = 1)
increase expenditure
cause no change in
expenditure
decrease expenditure
decrease expenditure
cause no change in
expenditure
increase expenditure
elastic (|ED| > 1)
Effects of Price Changes on
Expenditure
At any point on a demand curve,
buyers’ total expenditures is the area
of a rectangle with width equal to
quantity demanded and height equal
to price.
Elasticity and Total
Expenditure
Price
per
Laptop
$3,500
3,000
2,500
2,000
1,500
1,000
500
B
A
D
100,000 200,000 300,000 400,000 500,000 600,000 Quantity
of Laptops
Determinants of Elasticity
Short-run Elasticity
An elasticity measured just a
short time after a price change
Determinants of Elasticity
Specific Brands
Narrow Categories
Broad Categories
Tide Detergent –2.79
Transatlantic Air Travel –1.30
Tourism in Thailand
–1.20
Ground Beef
–1.02
Pork
–0.78
Milk
–0.54
Cigarettes
–0.45
Electricity
–0.40 to –0.50
Beer
–0.26
Eggs
–0.26
Gasoline
–0.20
Oil
–0.15
Recreation
–1.09
Clothing
Food
Imports
Transportation
–0.89
–0.67
–0.58
–0.56
Pepsi
Coke
–2.08
–1.71
Long-run Elasticity
Long-run Elasticity
An elasticity measured a year
or more after a price change
Short-run and Long-run
Elasticity
Short Run (a few months of less)
Long Run (a year or more)
Use public transit more often
Arrange a car pool
Get a tune-up
Drive more slowly on the highway
Eliminate unnecessary trips (use mail order
and the Internet instead of driving to stores;
locate goods by phone instead of driving
around; shop for food less often and buy
more each time)
It there are two cars, use the more
fuel-efficient one
Buy a more fuel-efficient car
Move closer to your job
Switch to a job closer to home
Move to a city where less driving is required
Short-run and Long-run
Elasticity
•Easier to find substitutes for an item in the
long run than in the short run
•Thus, demand is more elastic in the long
run than in the short run
•The more of their total budgets
households spend on an item, the more
elastic the demand for that item
Price Elasticity of Demand
•The more elastic the demand curve,
the more of an excise tax paid by
sellers
•The more inelastic the demand curve,
the more of the tax paid by buyers
Price Elasticity of Demand
(a)
(b)
Price
per
Ticket
Price
per
Ticket
S'
D
S'
S
$830
730
S
B
A
Tickets
11.3 (Millions per Year)
$730
B
7.0
A
D
Tickets
11.3 (Millions per Year)
Other Demand Elasticities
•Income Elasticity of Demand
•Cross-Price Elasticity of
Demand
Income Elasticity of
Demand
Income Elasticity of Demand
The percentage change demanded
caused by a 1-percent change in income
%Q
EI 
%I
D
Income Elasticity of Demand
Economic Necessity
A good with an income elasticity of demand
between 0 and 1
Economic Luxury
A good with an income elasticity of demand
greater than 1
Cross-Price Elasticity of
Demand
Cross-Price Elasticity of Demand
The percentage change in the the
quantity demanded of one good
caused by a 1-percent change in
the price of another good