Download Lecture 3 - Har Wai Mun

UBEA 1013: ECONOMICS
CHAPTER 3:
MARKET EFFICIENCY & ELASTICITY
3.1 The Market System
3.2 Constraint on the Market: Government Intervention
3.3 Market Efficiency & Surpluses Maximization
3.4 Elasticity
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UBEA 1013: ECONOMICS
Microeconomics scope for UBEA 1013 Economics
Output (Product) Market
DD & SS Interaction
Utility (excluded)
Consumer surplus
Factors effect DD
Elasticity
Changes in DD / SS:
Equilibrium Price &
Quantity
Market System
Market Efficiency
Government
Intervention
Production
Supplier surplus
Factors effect SS
Elasticity
Market structure
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UBEA 1013: ECONOMICS
3.1 The Market System
Stability or equilibrium point:
supply = demand
This situation achieved and re-achieved after
disequilibrium through the an important
functions of the market (price system):
PRICE RATIONING
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UBEA 1013: ECONOMICS
3.1 The Market System
Price Rationing:
Definition:
i. Allocates output to consumers and resources to
firms through price adjustment.
ii. Price rationing when Qty DD > Qty SS (shortage)
iii. Allocation based on willingness & ability to pay
(answering the “for whom to produce” problem).
Figure 3.1: Price Rationing
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UBEA 1013: ECONOMICS
3.1 The Market System
Note:
Price rationing is consider as market oriented approach
because:
i. Allocates through open market
ii. No government intervention
Weaknesses (market failure): Inability to recognize that
each society have the right, necessity or needs to certain
type of outputs like health care, accommodation, basic
food and safety
Use non-market
/ non-pricing
approach
lottery approach, political
approach and mixed approach
government intervention
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UBEA 1013: ECONOMICS
3.1 The Market System
Situations of Market failure:
a) External benefit:
i. Free-riders
ii. Road (transport), hospital (public health), dam
(flood/electricity)
b) External cost:
i. Negative effect/cost to others
ii. Pollution
c) Imperfect information:
i. Seller has more info than buyer
ii. “Lemon market” & info disclosure
d) Imperfect competition:
i. Market controlled by monopoly, cartel, illegal cooperation
ii. Government ownership, law & regulation
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UBEA 1013: ECONOMICS
3.2 Constraint on the Market:
Case for Government Intervention
a) Price ceiling:
i. Maximum price sellers may charge
ii. To control unjust high price
iii. Excess demand (Ration coupon as complement
action to control DD)
iv. Emerging of black market
Figure 3.1 (Price Ceiling at $3.27)
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UBEA 1013: ECONOMICS
3.2 Government Intervention
b) Ration coupon:
i. Ticket/coupon entitle individual to purchase
ii. Coupons trading – alike price rationing
iii. Serve as redistributing income
c) Favored customer:
i. Special treatment
ii. Results in hidden cost
d) Waiting in line (Queuing):
i. Product cost = cost of waiting
ii. A form of deadweight loss
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UBEA 1013: ECONOMICS
3.2 Government Intervention
e) Price floor:
i. Minimum price for buying – selling
ii. To adjust unfair low price
iii. Excess of supply (government has to buy up
excess)
iv. Alternative: subsidization
Figure 3.2: Price Floor: Minimum Wages
f) Other restriction:
i. Price control
ii. Licensing
iii. Taxes
iv. Quota
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UBEA 1013: ECONOMICS
3.3 Market Efficiency & Surpluses Maximization
What is “Efficient Market”?:
i. Pareto efficient: A market is efficient if there is no
way to make any person better off without hurting
anybody else. (Relate to PPF)
ii. Relate to PPF: Reduce production of product “Y” to
increase production of product “X”.
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UBEA 1013: ECONOMICS
3.3 Efficiency & Surpluses
What is “Consumer Surplus”?:
i. Extra value individual received
ii. What people willing to pay
iii. Maximum amount willing to pay minus current
market price
Figure 3.3: Consumer Surplus
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UBEA 1013: ECONOMICS
3.3 Efficiency & Surpluses
What is “Producer Surplus”?:
i. Extra value producer received
ii. What producer pay for the right to sell at current
price
iii. Minimum amount willing to sell minus current
market price
Figure 3.4: Producer Surplus
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UBEA 1013: ECONOMICS
3.3 Efficiency & Surpluses
Surplus maximization:
i. Market efficient = maximize sum of consumer &
producer surpluses
ii. Achieved when DD = SS
Figure 3.5(a): Surplus maximization
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UBEA 1013: ECONOMICS
3.3 Efficiency & Surpluses
Deadweight loss:
i. Losses of consumer and producer surplus that are
not transferred to other parties
ii. Occur from under and over production
Figure 3.5(b): Deadweight loss
(under production)
Figure 3.6: Deadweight loss
(over production)
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UBEA 1013: ECONOMICS
3.4 Elasticity
A measure of how “responsive” demand is to some
change in price or income:
i. The slop of a demand function (∆q/∆p)
ii. The slope of the demand curve (∆p/∆q)
iii. Elasticity method
Figure 3.5(a): Demand Curve Slope & Responsiveness
slope 
23
1

10  5
5
slope 
23
1

160  80
80
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UBEA 1013: ECONOMICS
3.4 Elasticity
Elasticity is a general concept to:
i. quantify the response in one variable when another
variable changes
ii. measure the percentage change in one variable
brought about by a 1 percent change in some
other variable
iii. Elasticity is unit free
Type of elasticity:
i. Price elasticity of demand
ii. Income elasticity
iii. Cross-price elasticity
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UBEA 1013: ECONOMICS
3.4 Elasticity
Price elasticity of demand calculation: How responsive
consumers are to changes in the price of a product
ε = [(∆q/q)*100%] / [(∆p/p)*100%] ………… (Equation 3.1)
= (∆q/q)*100% * (p/∆p)*(1/100%)
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
Ratio of
price to
quantity
multiply
Slope of
demand
function
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UBEA 1013: ECONOMICS
3.4 Elasticity
Example: Use Figure 3.7 (a) & (b). Assumed price
decrease from P1 = $3 to P2 = $2.
For Figure 3.7 (a):
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
= (3/5)*[(10 – 5)/(2 – 3)]
=–3
or
Same answer for Figure 3.7 (b):
proving that different unit of measurement did
not effect elasticity.
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UBEA 1013: ECONOMICS
3.4 Elasticity
BUT different answer if assumed price increase
from P1 = $2 to P2 = $3.
Solution: Mid-point formula
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UBEA 1013: ECONOMICS
3.4 Elasticity
NOTE: Which one is more elastic?
Less elastic
More elastic
In negative
value
–5
–4
–3
–2
–1
More elastic
Less elastic
In absolute
value
1
2
3
4
5
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UBEA 1013: ECONOMICS
Figure 3.8(a): Perfectly Inelastic
3.4 Elasticity
Figure 3.8(b): Perfectly Elastic
Table 3.1 shows values & types for elasticity of demand
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UBEA 1013: ECONOMICS
3.4 Elasticity
Elasticity of linear demand curve:
i. Change from point to point
ii. Decrease when move downward
iii. Elastic at upper range, inelastic at lower range
Figure 3.9: Elasticity of a Linear Demand Curve
At middle point, elasticity = 1
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UBEA 1013: ECONOMICS
3.4 Elasticity
Calculus proving (No. 1):
Consider a linear demand curve, q = a – bp
i. The slope = – b
ii. If q = 0; p = a / b
(price intercept)
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
= (p/q)* (– b)
= [p / (a – bp)]* [– b]
(›› q = a – bp)
– 1 = [p / (a – bp)]* [– b]
– 1 = (– bp) / (a – bp)
bp = (a – bp)
p=a/b
2bp = a
p = a / 2b
(middle point)
(unitary elasticity)
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UBEA 1013: ECONOMICS
3.4 Elasticity
Calculus proving (No. 2):
Linear demand curve, q = a – bp
At price axis intercept, q = 0 & p = a / b
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
= [(a/b) / 0]* (– b)
=∞
(›› infinity elasticity at price intercept)
p=a/b
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UBEA 1013: ECONOMICS
3.4 Elasticity
Calculus proving (No. 3):
Linear demand curve, q = a – bp
At quantity axis intercept, p = 0 & q = a
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
= (0/a)*(– b)
=0
(›› zero elasticity at qty intercept)
p=a/b
a
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UBEA 1013: ECONOMICS
3.4 Elasticity
Price increase < Qty drop
›› increase price = reduced revenue
Price increase = Qty drop
›› revenue maximization
Price increase > Qty drop
›› increase price = increase revenue
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UBEA 1013: ECONOMICS
3.4 Elasticity
Cross price elasticity:
Measure of the response of the quantity of one good
demanded to a change in the price of another good
ε = [(∆q/q)*100%] / [(∆p’/p’)*100%]
For substitute product: ε(p’) positive (the price of one product and
quantity demanded for another product move in the same direction)
For complement product: ε(p’) negative (the price of one product
and quantity demanded for another product move in the opposite direction)
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UBEA 1013: ECONOMICS
3.4 Elasticity
Others elasticity:
Elasticity of supply is a measure of the response of
quantity of a good supplied to a change in price of that
good. Its value is likely to be positive in output markets
due to the law of supply.
Elasticity of labor supply is a measure of the response of
labor supplied to a change in the price of labor
End
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