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Unformatted text preview: Principles of Economics I
Economics 101 Announcements Readings: Next class: Chapter 6 and some notes available this afternoon on CTools Discussion Sections this week New assignment is available Take a look before discussion section I'm sorry it was late Export Tax
Price/unit PWorld PWorld t Decrease in Increase in Producer Consumer Tax Revenue Surplus Surplus DWL t Domestic Supply Market Demand Exports QD DomesticD emand QS' QS Quantity QD' Export tax and the world price The export tax is a tax on trade Reduces trade in equilibrium Specifically, reduces supply of goods to the world market If domestic producers represent a significant portion of world supply, this will shift the world supply curve left Word prices tend to rise Increase in consumer surplus Price/unit PW1 PW0 PW1 t Export Tax
Gain in Social Tax revenue Surplus Domestic Supply Market Demand Market Demand t DWL Lost producer surplus DomesticD emand QS' Exports QD QD' QS Quantity The Sugar Quota Revisited
$/lb Domestic Supply Market Supply $0.21 $0.08 1.0 16.8 20.3 DomesticD emand 24.3 Lbs (billions) The Demand Function Example: Sugar Demand Two points on the demand curve: (P0, Q0) = (0.08, 24.3) (P1, Q1) = (0.21, 20.3) Suppose the demand curve is linear i.e. slope between any two points is the same What is the slope of the demand curve? Slope = rise = (0.21  0.08) =  0.13 = 0.0325 run (20.3  24.3) 4 The Demand Function The slope between any two points on the demand curve is the same E.g.. slope between (P,Qd) (0.08, 24.3) must equal  0.0325
rise ( P  0.08) i.e. = = 0.0325 run (Qd  24.3) Rearrange this: Qd= 26.76 30.77 P The demand function Qd = 26.76 30.77 P What do 26.76 and 30.77 mean? If P = 0, then Qd = 26.76 If P rises by $1/lb, quantity demanded falls by 30.77 billion pounds i.e 26.76 is the intercept on the horizontal axis i.e. 30.77 is the inverse of the slope of the demand curve The Sugar Quota Revisited
$/lb DomesticD emand Slope = 1/30.77 = 0.0375 $0.21 $0.08 20.3 24.3 26.76 Lbs (bil) The Linear Demand Curve Generically: Qd = a + b P where a = intercept on the Qdaxis b = inverse of the slope (b < 0) The slope of the demand function Slope of linear demand curve is 1/b Demand curves are negatively sloped b < 0 b and demand curve slope reflect the sensitivity of demand to changes in the price If demand does not respond significantly to changes in price then the demand curve is steep and b is very small If demand responds a lot to changes in price then the demand curve is flat and b is large Sensitivity of demand to changes in price
P Demand is relatively price elastic, i.e. quantity demanded is sensitive to price changes b is large and negative P0 P1 Q0 Q1 Q Sensitivity of demand to changes in price
P Demand is infinitely or perfectly price elastic, i.e. quantity demanded responds overwhelmingly to changes in price b is not defined P0 Q Elastic Demand Relatively sensitive to price changes Price cofficient in the demand function, b, is a large negative number Typically the result of the availability of close substitutes for the good Demand for domestically produced goods was very elastic when identical exports were available Demand for one brand of rice is likely to be very elastic: If the price of that brand rises, most buyers will substitute to another brand Sensitivity of demand to changes in price
P Demand is relatively price inelastic, i.e. quantity demanded is not sensitive to price changes P0 b is small and negative P1 Q0 Q1 Q Sensitivity of demand to changes in price
P Demand is perfectly price inelastic, i.e. quantity demanded is totally insensitive to price changes b=0 P0 P1 Q0 Q Inelastic Demand Relatively insensitive to price changes Price coefficient in the demand function, b, is a small negative number Typically the result of the scarcity of close substitutes for the good Demand for specific drugs tend to be inelastic Firms often advertise to convince people that their products do not have close substitutes E.g. Insulin Less elastic demand curves will allow high prices without as great a loss in sales The Qaxis intercept Recall our simple linear demand function: Qd = a + b P where a = intercept on the Qdaxis = quantity demanded if P = 0 The value of a will depend on many factors Changes in these factors will be shown to shift the demand function. Qd = a + b P
P Demand Slope = 1/b P0+1 P0 1 b
Q0b Q0 a0 a1 Q The Qaxis intercept Those factors that shift the demand curve will be associated with changes in the Q axis intercept
Changes in income Changes in prices of related goods (substitutes and complements) Changes in population Changes in environmental factors Changes in tastes Advertising expenditures A more general model of demand Again, use a linear specification for simplicity:
Qd = b0 + b1 P + b2 Psub + b3 Pcomp + b4 Y + b5 Pop + ... Where: P = own price of the good Psub = price of a substitute Pcomp = price of a complement Y = income (e.g. average household income) Pop = population etc A more general model of demand Rearranging the same expression: Q = [b + b P + b P + b Y + b Pop + ...] + b P d 0 2 sub 3 comp 4 5 1 = a + b1 P where a = [b0 + b2 Psub + b3 Pcomp + b4 Y + b5 Pop + ...] i.e. changes in demand determinants other than own price will simply change the Qaxis intercept Call these "demand shifters" or "shift variables" Substitutes and Complements If an increase in price of good A increases demand for good B, then good A is a substitute for good B
Implication is that the coefficient in front of PA in the good B demand function must be positive An increase in P increases the Qaxis intercept of A the demand curve i.e. shifts it to the right Substitutes and Complements If an increase in price of good A decreases demand for good B, then good A is a complement for good B
Implication is that the coefficient in front of PA in the good B demand function must be negative An increase in P decreases the Qaxis intercept of A the demand curve for good B i.e. shifts it to the left Normal and Inferior Goods If an increase in income increases demand for good B, then good B is normal Implication is that the coefficient in front of Y in the good B demand function must be positive An increase in Y increases the Qaxis intercept of the demand curve for good B i.e. shifts it to the right Normal and Inferior Goods If an increase in income decreases demand for good B, then good B is inferior Implication is that the coefficient in front of Y in the good B demand function must be negative An increase in Y decreases the Qaxis intercept of the demand curve for good B i.e. shifts it to the left ...
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 Winter '08
 Gerson
 Economics

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