3 - TOPIC 3 ANALYSIS OF PRICE CONTROL AND ELASTICITY TOPICS...

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TOPIC 3 ANALYSIS OF PRICE CONTROL AND ELASTICITY
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TOPICS Efficiency of market equilibrium revisited Minimum wage Illegal drugs The price elasticity of demand The cross price elasticity The income elasticity The price elasticity of supply
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Market price is determined by the interaction of Demand and Supply. Demand P Q Supply P 1 Excess supply P 2 Excess demand Equilibrium P* Q*
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DEMAND AND CONSUMER SURPLUS An alternative way of interpreting the demand curve A demand curve is a marginal benefit curve. The value of one more unit of a good or service is its marginal benefit . How do we measure marginal benefit of a good? In the following figure, an individual demands bottled water. What is the marginal benefit of the 1 st bottle? Of the 2 nd bottle? Of the 9 th bottle?
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AN INDIVIDUAL DEMAND FOR BOTTLED WATER 10 9 8 7 6 5 4 3 2 1 0 1 2 3 4 5 6 7 8 9 Market Price of Bottled water A consumer’s demand P Q
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DEMAND AND CONSUMER SURPLUS Consumer surplus is the gap between the marginal benefit of a good and the price paid of it summed over the quantity bought. In the previous figure, what is the consumer surplus of the 1 st bottle? Of the 2 nd bottle? Of the 9 th bottle? How many bottles will the consumer buy? What is the total consumer surplus?
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CONSUMER SURPLUS FOR A MARKET The following figure illustrates that the total consumer surplus is the area under the demand curve and above the price line.
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CONSUMER SURPLUS FOR A MARKET OF BOTTELED WATER 9 8 7 6 5 4 3 2 1 P Q
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SUPPLY AND MARGINAL COST In a perfectly competitive market , the supply curve is the marginal cost curve. What is perfect competition? Perfect competition is an industry in which 1. many firms sell identical products to many buyers 2. there are no restrictions on entry into the industry 3. established firms have no advantage over new ones 4. sellers and buyers are well informed about prices. Examples of perfect competition farming, the manufacture of paper cups and plastic shopping bags, dry cleaning
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What is marginal cost? Marginal cost is the cost of producing one more unit of goods or services. An example of marginal cost.
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3 - TOPIC 3 ANALYSIS OF PRICE CONTROL AND ELASTICITY TOPICS...

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