Download demand

Unit 2 S/D and Consumer
Behavior
MARKETS AND COMPETITION
• A market is a group of buyers and sellers of a
particular good or service.
• The terms supply and demand refer to the
behavior of people . . . as they interact with
one another in markets.
MARKETS AND COMPETITION
• Buyers determine demand.
• Sellers determine supply
DEMAND
• Quantity demanded is the amount of a good that
buyers are willing and able to purchase.
• Law of Demand
– The law of demand states that, other things equal
(ceteris paribus), the quantity demanded of a good
falls when the price of the good rises.
• Substitution Effect
– Consumers have an incentive to substitute what is now a less
expensive product for similar products that are now relatively
more expensive
• Income Effect
– Lower price raises real income, enabling buyers to buy more of
the product
The Demand Curve: The Relationship between
Price and Quantity Demanded
• Demand Schedule
– The demand schedule is a table that shows the
relationship between the price of the good and
the quantity demanded.
Catherine’s Demand Schedule
The Demand Curve: The Relationship between
Price and Quantity Demanded
• Demand Curve
– The demand curve is a graph of the relationship
between the price of a good and the quantity
demanded.
Catherine’s Demand Schedule and Demand Curve
Price of
Ice-Cream Cone
$3.00
2.50
1. A decrease
in price ...
2.00
1.50
1.00
0.50
6 7 8 9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity
of cones demanded.
0 1 2 3 4 5
Copyright © 2004 South-Western
Market Demand versus Individual Demand
• Market demand refers to the sum of all
individual demands for a particular good or
service.
• Graphically, individual demand curves are
summed horizontally to obtain the market
demand curve.
Shifts in the Demand Curve
• Change in Quantity Demanded
– Movement along the demand curve.
– Caused by a change in the price of the product.
Changes in Quantity Demanded
Price of IceCream
Cones
A tax that raises the price of ice-cream
cones results in a movement along the
demand curve.
B
$2.00
A
1.00
D
0
4
8
Quantity of Ice-Cream Cones
Shifts in the Demand Curve
• Change in Demand
– A shift in the demand curve, either to the left or
right.
– Caused by any change that alters the quantity
demanded at every price.
Shifts in the Demand Curve
• Number of consumers
• Income of consumers
• Complement price change
• Expectations
• Substitute price change
• Tastes
Shifts in the Demand Curve
Price of
Ice-Cream
Cone
Increase
in demand
Decrease
in demand
Demand
curve, D 2
Demand
curve, D 1
Demand curve, D 3
0
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Shifts and Changes in Demand cont.
• A closer look at changes in income
– Normal Good
• A good that consumers
demand more when their
incomes increase
– Inferior Good
• A good that consumers
demand less when their
incomes increase
Consumer Income
Normal Good
Price of
Hamburgers
$3.00
An increase in
income...
2.50
Increase
in demand
2.00
1.50
1.00
0.50
D1
0 1
2 3 4 5 6 7 8 9 10 11 12
D2
Quantity of
Hamburgers
Consumer Income
Inferior Good
Price of Spam
$3.00
2.50
An increase in
income...
2.00
Decrease
in demand
1.50
1.00
0.50
D1
0 1
2 3 4 5 6 7 8 9 10 11 12
Quantity of
Spam
SUPPLY
• Quantity supplied is the amount of a good
that sellers are willing and able to sell.
• Law of Supply
– The law of supply states that, other things equal
(ceteris paribus), the quantity supplied of a good
rises when the price of the good rises.
The Supply Curve: The Relationship between
Price and Quantity Supplied
• Supply Schedule
– The supply schedule is a table that shows the
relationship between the price of the good and
the quantity supplied.
Ben’s Supply Schedule
Supplied
The Supply Curve: The Relationship between Price
and Quantity Supplied
• Supply Curve
– The supply curve is the graph of the relationship
between the price of a good and the quantity
supplied.
Ben’s Supply Schedule and Supply Curve
Price of
Ice-Cream
Cone
$3.00
1. An
increase
in price ...
2.50
2.00
1.50
1.00
0.50
0
1
2
3
4
5
6
7
8
9 10 11 12 Quantity of
Ice-Cream Cones
2. ... increases quantity of cones supplied.
Copyright©2003 Southwestern/Thomson Learning
Market Supply versus Individual Supply
• Market supply refers to the sum of all
individual supplies for all sellers of a particular
good or service.
• Graphically, individual supply curves are
summed horizontally to obtain the market
supply curve.
Shifts in the Supply Curve
• Change in Quantity Supplied
– Movement along the supply curve.
– Caused by a change in the price of the product.
Change in Quantity Supplied
Price of IceCream Cone
S
C
$3.00
A rise in the price of
ice cream cones
results in a
movement along
the supply curve.
A
1.00
0
1
5
Quantity of
Ice-Cream
Cones
Shifts in the Supply Curve
• Change in Supply
– A shift in the supply curve, either to the left or
right.
– Caused by a change in a determinant other than
price.
Shifts in the Supply Curve
•
•
•
•
•
Resource prices
Expectations
Number of producers
Technology changes
Government action (taxes, subsidies, and
regulations)
• Other goods prices
Shifts in the Supply Curve
Price of
Ice-Cream
Cone
Supply curve, S 3
Decrease
in supply
Supply
curve, S 1
Supply
curve, S 2
Increase
in supply
0
Quantity of
Ice-Cream Cones
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SUPPLY AND DEMAND TOGETHER
• Equilibrium refers to a situation in which the
price has reached the level where quantity
supplied equals quantity demanded.
– Equilibrium Price and Quantity
• On the graph, it is where supply and demand intersect
SUPPLY AND DEMAND TOGETHER
Demand Schedule
Supply Schedule
At $2.00, the quantity demanded is
equal to the quantity supplied!
The Equilibrium of Supply and Demand
Price of
Ice-Cream
Cone
Supply
Equilibrium
Equilibrium price
$2.00
Equilibrium
quantity
0
1
2
3
4
5
6
7
8
Demand
9 10 11 12 13
Quantity of Ice-Cream Cones
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Equilibrium
• Surplus
– When price > equilibrium price, then quantity
supplied > quantity demanded.
• There is excess supply or a surplus.
• Suppliers will lower the price to increase sales, thereby
moving toward equilibrium.
Markets Not in Equilibrium
(a) Excess Supply
Price of
Ice-Cream
Cone
Supply
Surplus
$2.50
2.00
Demand
0
4
Quantity
demanded
7
10
Quantity
supplied
Quantity of
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning
Equilibrium
• Shortage
– When price < equilibrium price, then quantity
demanded > the quantity supplied.
• There is excess demand or a shortage.
• Suppliers will raise the price due to too many buyers
chasing too few goods, thereby moving toward
equilibrium.
Markets Not in Equilibrium
(b) Excess Demand
Price of
Ice-Cream
Cone
Supply
$2.00
1.50
Shortage
Demand
0
4
Quantity
supplied
7
10
Quantity
demanded
Quantity of
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning
Equilibrium
• Law of supply and demand
– The claim that the price of any good adjusts to
bring the quantity supplied and the quantity
demanded for that good into balance.
How an Increase in Demand Affects the Equilibrium
Price of
Ice-Cream
Cone
1. Hot weather increases
the demand for ice cream . . .
Supply
New equilibrium
$2.50
2.00
2. . . . resulting
in a higher
price . . .
Initial
equilibrium
D
D
0
7
3. . . . and a higher
quantity sold.
10
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
How a Decrease in Supply Affects the Equilibrium
Price of
Ice-Cream
Cone
S2
1. An increase in the
price of sugar reduces
the supply of ice cream. . .
S1
New
equilibrium
$2.50
Initial equilibrium
2.00
2. . . . resulting
in a higher
price of ice
cream . . .
Demand
0
4
7
3. . . . and a lower
quantity sold.
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
Elasticity . . .
• … allows us to analyze supply and demand
with greater precision.
• … is a measure of how much buyers and
sellers respond to changes in market
conditions
THE ELASTICITY OF DEMAND
• Price elasticity of demand is a measure of how
much the quantity demanded of a good
responds to a change in the price of that
good.
• Price elasticity of demand is the percentage
change in quantity demanded given a percent
change in the price.
The Price Elasticity of Demand and Its
Determinants
•
•
•
•
•
Availability of Close Substitutes
Necessities versus Luxuries
Definition of the Market
Time Horizon
% of Income
Computing the Price Elasticity of Demand
• The price elasticity of demand is computed as
the percentage change in the quantity
demanded divided by the percentage change
in price.
Price elasticity of demand =
Percentage change in quantity demanded
Percentage change in price
The Midpoint Method: A Better Way to
Calculate Percentage Changes and Elasticities
• The midpoint formula is preferable when
calculating the price elasticity of demand
because it gives the same answer regardless
of the direction of the change.
Price elasticity of demand =
Percentage change in quantity demanded
Percentage change in price
(Q2  Q1 ) / [(Q2  Q1 ) / 2]
Price elasticity of demand =
(P2  P1 ) / [(P2  P1 ) / 2]
The Midpoint Method: A Better Way to
Calculate Percentage Changes and Elasticities
• Example: If the price of an ice cream cone
increases from $2.00 to $2.20 and the amount
you buy falls from 10 to 8 cones, then your
elasticity of demand, using the midpoint
formula, would be calculated as:
(10  8)
22%
(10  8) / 2

 2.32
(2.20  2.00)
9.5%
(2.00  2.20) / 2
The Variety of Demand Curves
• Inelastic Demand
– Quantity demanded does not respond strongly to
price changes.
– Ed < 1
• Elastic Demand
– Quantity demanded responds strongly to changes
in price.
– Ed > 1
The Variety of Demand Curves
• Perfectly Inelastic
– Quantity demanded does not respond to price
changes.
• Perfectly Elastic
– Quantity demanded changes infinitely with any
change in price.
• Unit Elastic
– Quantity demanded changes by the same
percentage as the price.
The Variety of Demand Curves
• Because the price elasticity of demand
measures how much quantity demanded
responds to the price, it is closely related to
the slope of the demand curve.
The Price Elasticity of Demand
(a) Perfectly Inelastic Demand: Elasticity Equals 0
Price
Demand
$5
4
1. An
increase
in price . . .
0
100
Quantity
2. . . . leaves the quantity demanded unchanged.
Copyright©2003 Southwestern/Thomson Learning
The Price Elasticity of Demand
(e) Perfectly Elastic Demand: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
demanded is zero.
$4
Demand
2. At exactly $4,
consumers will
buy any quantity.
0
3. At a price below $4,
quantity demanded is infinite.
Quantity
Total Revenue and the Price Elasticity of
Demand
• Total revenue is the amount paid by buyers
and received by sellers of a good.
• Computed as the price of the good times the
quantity sold.
TR = P x Q
Total Revenue
Price
$4
P × Q = $400
(revenue)
P
0
Demand
100
Quantity
Q
Copyright©2003 Southwestern/Thomson Learning
Elasticity and Total Revenue along a Linear
Demand Curve
• With an inelastic demand curve, an increase in
price leads to a decrease in quantity that is
proportionately smaller. Thus, total revenue
increases.
Figure 3 How Total Revenue Changes When Price Changes:
Inelastic Demand
Price
Price
… leads to an Increase in
total revenue from $100 to
$240
An Increase in price from $1
to $3 …
$3
Revenue = $240
$1
Demand
Revenue = $100
0
100
Quantity
Demand
0
80
Quantity
Copyright©2003 Southwestern/Thomson Learning
Elasticity and Total Revenue along a Linear
Demand Curve
• With an elastic demand curve, an increase in
the price leads to a decrease in quantity
demanded that is proportionately larger. Thus,
total revenue decreases.
How Total Revenue Changes When Price Changes: Elastic
Demand
Price
Price
… leads to an decrease in
total revenue from $200 to
$100
An Increase in price from $4
to $5 …
$5
$4
Demand
Demand
Revenue = $200
0
50
Revenue = $100
Quantity
0
20
Quantity
Copyright©2003 Southwestern/Thomson Learning
Elasticity of a Linear Demand Curve
Relationship between Demand and Total Revenue curves…on board
Income Elasticity of Demand
• Income elasticity of demand measures how
much the quantity demanded of a good
responds to a change in consumers’ income.
• It is computed as the percentage change in
the quantity demanded divided by the
percentage change in income.
Computing Income Elasticity
Percentage change
in quantity demanded
Income elasticity of demand =
Percentage change
in income
Income Elasticity
• Types of Goods
– Normal Goods
• Elasticity is positive
– Inferior Goods
• Elasticity is negative
• Higher income raises the quantity demanded
for normal goods but lowers the quantity
demanded for inferior goods.
Income Elasticity
• Goods consumers regard as necessities tend
to be income inelastic
– Examples include food, fuel, clothing, utilities, and
medical services.
• Goods consumers regard as luxuries tend to
be income elastic.
– Examples include sports cars, furs, and expensive
foods.
THE ELASTICITY OF SUPPLY
• Price elasticity of supply is a measure of how
much the quantity supplied of a good
responds to a change in the price of that
good.
• Price elasticity of supply is the percentage
change in quantity supplied resulting from a
percent change in price.
The Price Elasticity of Supply
(a) Perfectly Inelastic Supply: Elasticity Equals 0
Price
Supply
$5
4
1. An
increase
in price . . .
0
100
Quantity
2. . . . leaves the quantity supplied unchanged.
Copyright©2003 Southwestern/Thomson Learning
The Price Elasticity of Supply
(e) Perfectly Elastic Supply: Elasticity Equals Infinity
Price
1. At any price
above $4, quantity
supplied is infinite.
$4
Supply
2. At exactly $4,
producers will
supply any quantity.
0
3. At a price below $4,
quantity supplied is zero.
Quantity
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Determinants of Elasticity of Supply
• Ability of sellers to change the amount of the
good they produce.
– Beach-front land is inelastic.
– Books, cars, or manufactured goods are elastic.
• Time period.
– Supply is more elastic in the long run.
Computing the Price Elasticity of Supply
• The price elasticity of supply is computed as
the percentage change in the quantity
supplied divided by the percentage change in
price.
Percentage change
in quantity supplied
Price elasticity of supply =
Percentage change in price
THREE APPLICATIONS OF SUPPLY, DEMAND, AND
ELASTICITY
• Can good news for farming be bad news for
farmers?
• What happens to wheat farmers and the
market for wheat when university agronomists
discover a new wheat hybrid that is more
productive than existing varieties?
Figure 8 An Increase in Supply in the Market for Wheat
Price of
Wheat
2. . . . leads
to a large fall
in price . . .
1. When demand is inelastic,
an increase in supply . . .
S1
S2
$3
2
Demand
0
100
110
Quantity of
Wheat
3. . . . and a proportionately smaller
increase in quantity sold. As a result,
revenue falls from $300 to $220.
Copyright©2003 Southwestern/Thomson Learning
Cross Elasticity of Demand
• Cross elasticity of demand measures how
sensitive consumer purchases of one product
(say, X) are to a change in the price of some
other product (say, Y).
Exy = (% change in Qd of X) / (% change in P of Y)
Cross Elasticity of Demand
• If Exy is positive, the two products are substitutes.
– The larger the number, the greater the substitutability
of the two products
• If Exy is negative, the two products are
complements,
– The larger the negative number, the greater
complementarity of the two products.
• A zero or near zero cross elasticity suggests that
the products are independent of each other.
REVISITING THE MARKET
EQUILIBRIUM
• Do the equilibrium price and quantity
maximize the total welfare of buyers and
sellers?
• Market equilibrium reflects the way markets
allocate scarce resources.
• Whether the market allocation is desirable
can be addressed by welfare economics.
Welfare Economics
• Welfare economics is the study of how the
allocation of resources affects economic wellbeing.
• Buyers and sellers receive benefits from taking
part in the market.
• The equilibrium in a market maximizes the
total welfare of buyers and sellers.
Welfare Economics
• Consumer surplus measures economic welfare
from the buyer’s side.
• Producer surplus measures economic welfare
from the seller’s side.
CONSUMER SURPLUS
• Willingness to pay is the maximum amount
that a buyer will pay for a good.
• It measures how much the buyer values the
good or service.
CONSUMER SURPLUS
• Consumer surplus is the buyer’s willingness to
pay for a good minus the amount the buyer
actually pays for it.
Four Possible Buyers’ Willingness to Pay
Copyright©2004 South-Western
The Demand Schedule and the
Demand Curve
The Demand Schedule and the Demand Curve
Price of
Album
John’s willingness to pay
$100
Paul’s willingness to pay
80
George’s willingness to pay
70
Ringo’s willingness to pay
50
Demand
0
1
2
3
4
Quantity of
Albums
Copyright©2003 Southwestern/Thomson Learning
Measuring Consumer Surplus with the Demand Curve
(a) Price = $80
Price of
Album
$100
John’s consumer surplus ($20)
80
70
50
Demand
0
1
2
3
4
Quantity of
Albums
Copyright©2003 Southwestern/Thomson Learning
Measuring Consumer Surplus with the Demand Curve
(b) Price = $70
Price of
Album
$100
John’s consumer surplus ($30)
80
Paul’s consumer
surplus ($10)
70
50
Total
consumer
surplus ($40)
Demand
0
1
2
3
4 Quantity of
Albums
Copyright©2003 Southwestern/Thomson Learning
Using the Demand Curve to Measure Consumer
Surplus
• The area below the demand curve and above
the price measures the consumer surplus in
the market.
How the Price Affects Consumer Surplus
(a) Consumer Surplus at Price P
Price
A
Consumer
surplus
P1
B
C
Demand
0
Q1
Quantity
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How the Price Affects Consumer Surplus
(b) Consumer Surplus at Price P
Price
A
Initial
consumer
surplus
P1
P2
0
C
B
Consumer surplus
to new consumers
F
D
E
Additional consumer
surplus to initial
consumers
Q1
Demand
Q2
Quantity
Copyright©2003 Southwestern/Thomson Learning
What Does Consumer Surplus Measure?
• Consumer surplus, the amount that buyers are
willing to pay for a good minus the amount
they actually pay for it, measures the benefit
that buyers receive from a good as the buyers
themselves perceive it.
PRODUCER SURPLUS
• Producer surplus is the amount a seller is paid
for a good minus the seller’s cost.
• It measures the benefit to sellers participating
in a market.
The Costs of Four Possible Sellers
Copyright©2004 South-Western
The Supply Schedule and the Supply
Curve
The Supply Schedule and the Supply Curve
Using the Supply Curve to Measure Producer
Surplus
• The area below the price and above the
supply curve measures the producer surplus in
a market.
Measuring Producer Surplus with the Supply Curve
(a) Price = $600
Price of
House
Painting
Supply
$900
800
600
500
Grandma’s producer
surplus ($100)
0
1
2
3
4
Quantity of
Houses Painted
Copyright©2003 Southwestern/Thomson Learning
Measuring Producer Surplus with the Supply Curve
(b) Price = $800
Price of
House
Painting
$900
Supply
Total
producer
surplus ($500)
800
600
Georgia’s producer
surplus ($200)
500
Grandma’s producer
surplus ($300)
0
1
2
3
4
Quantity of
Houses Painted
Copyright©2003 Southwestern/Thomson Learning
How the Price Affects Producer Surplus
(a) Producer Surplus at Price P
Price
Supply
P1
B
Producer
surplus
C
A
0
Q1
Quantity
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How the Price Affects Producer Surplus
(b) Producer Surplus at Price P
Price
Supply
Additional producer
surplus to initial
producers
P2
P1
D
E
F
B
Initial
producer
surplus
C
Producer surplus
to new producers
A
0
Q1
Q2
Quantity
Copyright©2003 Southwestern/Thomson Learning
MARKET EFFICIENCY
• Consumer surplus and producer surplus may
be used to address the following question:
– Is the allocation of resources determined by free
markets in any way desirable?
MARKET EFFICIENCY
Total surplus
= Consumer surplus + Producer surplus
or
Total surplus
= Value to buyers – Cost to sellers
MARKET EFFICIENCY
• Efficiency is the property of a resource
allocation of maximizing the total surplus
received by all members of society.
Consumer and Producer Surplus in the Market Equilibrium
Price A
D
Supply
Consumer
surplus
Equilibrium
price
E
Producer
surplus
B
Demand
C
0
Equilibrium
quantity
Quantity
Copyright©2003 Southwestern/Thomson Learning
Supply, Demand, and Government
Policies
• In a free, unregulated market system, market
forces establish equilibrium prices and
exchange quantities.
• While equilibrium conditions may be efficient,
it may be true that not everyone is satisfied.
• One of the roles of economists is to use their
theories to assist in the development of
policies.
CONTROLS ON PRICES
• Are usually enacted when policymakers
believe the market price is unfair to buyers or
sellers.
• Result in government-created price ceilings
and floors.
CONTROLS ON PRICES
• Price Ceiling
– A legal maximum on the price at which a good can
be sold.
• Price Floor
– A legal minimum on the price at which a good can
be sold.
A Market with a Price Ceiling
(b) A Price Ceiling That Is Binding
Price of
Ice-Cream
Cone
Supply
Equilibrium
price
$3
2
Price
ceiling
Shortage
Demand
0
75
125
Quantity
supplied
Quantity
demanded
Quantity of
Ice-Cream
Cones
Copyright©2003 Southwestern/Thomson Learning
CASE STUDY: Rent Control in the Short Run and Long
Run
• Rent controls are ceilings placed on the rents
that landlords may charge their tenants.
• The goal of rent control policy is to help the
poor by making housing more affordable.
• One economist called rent control “the best
way to destroy a city, other than bombing.”
Rent Control in the Short Run and in the Long Run
(a) Rent Control in the Short Run
(supply and demand are inelastic)
Rental
Price of
Apartment
Supply
Controlled rent
Shortage
Demand
0
Quantity of
Apartments
Copyright©2003 Southwestern/Thomson Learning
Rent Control in the Short Run and in the Long Run
(b) Rent Control in the Long Run
(supply and demand are elastic)
Rental
Price of
Apartment
Supply
Controlled rent
Shortage
0
Demand
Quantity of
Apartments
Copyright©2003 Southwestern/Thomson Learning
A Market with a Price Floor
(b) A Price Floor That Is Binding
Price of
Ice-Cream
Cone
Supply
Surplus
$4
Price
floor
3
Equilibrium
price
Demand
0
80
Quantity
demanded
Quantity of
Quantity Ice-Cream
Cones
supplied
120
Copyright©2003 Southwestern/Thomson Learning
The Minimum Wage
• An important example of a price floor is the
minimum wage. Minimum wage laws dictate
the lowest price possible for labor that any
employer may pay.
How the Minimum Wage Affects the Labor Market
Wage
Labor surplus
(unemployment)
Labor
Supply
Minimum
wage
Labor
demand
0
Quantity
demanded
Quantity
supplied
Quantity of
Labor
Copyright©2003 Southwestern/Thomson Learning
TAXES
• Governments levy taxes to raise revenue for
public projects.
How Taxes on Buyers (and Sellers) Affect Market
Outcomes
• Taxes discourage market activity.
• When a good is taxed, the
quantity sold is smaller.
• Buyers and sellers share
the tax burden.
Elasticity and Tax Incidence
• Tax incidence is the manner in which the
burden of a tax is shared among participants
in a market.
• The economic burden of a tax is independent
of the legal burden.
Elasticity and Tax Incidence
• Tax incidence is the study of who bears the
burden of a tax.
• Taxes result in a change in market equilibrium.
• Buyers pay more and sellers receive less,
regardless of whom the tax is levied on.
A Tax on Buyers
Price of
Ice-Cream
Price
Cone
buyers
pay
$3.30
Price
3.00
2.80
without
tax
Price
sellers
receive
Supply, S1
Equilibrium without tax
Tax ($0.50)
A tax on buyers
shifts the demand
curve downward
by the size of
the tax ($0.50).
Equilibrium
with tax
D1
D2
0
90
100
Quantity of
Ice-Cream Cones
Copyright©2003 Southwestern/Thomson Learning
A Tax on Sellers
Price of
Ice-Cream
Price
Cone
buyers
pay
$3.30
3.00
Price
2.80
without
tax
S2
Equilibrium
with tax
S1
Tax ($0.50)
A tax on sellers
shifts the supply
curve upward
by the amount of
the tax ($0.50).
Equilibrium without tax
Price
sellers
receive
Demand, D1
0
90
100
Quantity of
Ice-Cream Cones
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A Payroll Tax
Wage
Labor supply
Wage firms pay
Tax wedge
Wage without tax
Wage workers
receive
Labor demand
0
Quantity
of Labor
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ELASTICITY AND TAX INCIDENCE
So, how is the burden of the tax divided?
• The burden of a tax falls more
heavily on the side of the
market that is less elastic.
How the Burden of a Tax Is Divided
(a) Elastic Supply, Inelastic Demand
Price
1. When supply is more elastic
than demand . . .
Price buyers pay
Supply
Tax
2. . . . the
incidence of the
tax falls more
heavily on
consumers . . .
Price without tax
Price sellers
receive
3. . . . than
on producers.
0
Demand
Quantity
Copyright©2003 Southwestern/Thomson Learning
How the Burden of a Tax Is Divided
(b) Inelastic Supply, Elastic Demand
Price
1. When demand is more elastic
than supply . . .
Price buyers pay
Supply
Price without tax
3. . . . than on
consumers.
Tax
2. . . . the
incidence of
the tax falls
more heavily
on producers . . .
Price sellers
receive
0
Demand
Quantity
Copyright©2003 Southwestern/Thomson Learning
Consumer Behavior and Utility
• Utility is want satisfying power
• Marginal utility is extra utility gained
• Law of diminishing marginal utility is the fact
that utility decreases as you get more a
product
• Total utility is total satisfaction gained
• Goal is to maximize total utility given your
budget constraint
Consumer Behavior and Utility
• Determined using marginal utility per dollar
• Read Chapter 19 and answer questions 1-4 on
page 370