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Unformatted text preview: C H A P T E R 18 Elasticities, Price Distorting Policies and Non-Price Rationing This chapter is the first of five to treat violations of the first welfare theorem in com- petitive settings and the first of three that investigates the role of policy-induced price distortions. It begins, however, with a full treatment of the concept of elastic- ity, a topic we have saved until now so that we can discuss elasticity with respect to all the economic relationships we have derived. Our primary focus is on price elas- ticities as they are most relevant to the topic of policy-induced price distortions. We then introduce the most obvious way in which policy can distort prices — through explicit restrictions on prices in the form of price ceilings and price floors. Our treatment of these topics is an equilibrium treatment in the sense that we take the view that the emergence of shortages or surpluses under such policies is a disequi- librium phenomenon — and that, in the absence of rationing through prices, some non-price rationing mechanism will emerge and define the new equilibrium under any of these policies. Chapter Highlights The main points of the chapter are: 1. Elasticity refers to the responsiveness of behavior to some aspect of the eco- nomic environment and is defined as the percentage change in the observed behavior resulting from a one percent change in the economic variable. Elas- ticities of consumer demand, for instance, can be defined relative to changes in any price or changes in income; elasticities of output supply or input de- mand can be defined relative to changes in input or output prices; etc. The price elasticity of demand varies from zero to minus infinity along any linear demand curve , with consumer spending increasing as a result of a price in- crease when price elasticity lies between 0 and − 1 and decreasing when the elasticity lies between − 1 and −∞ . 419 18A. Solutions to Within-Chapter-Exercises for Part A 2. The division of surplus in the market depends in part on the elasticity of demand and supply — and the size of the impact of price distorting policies on the market similarly depends on price elasticities . 3. The imposition of price floors above the equilibrium price results in a dis- equilibrium surplus . Since it cannot be an equilibrium for producers to produce goods they cannot sell, some non-price rationing mechanism then leads to a new equilibrium. This may arise from producers expending ad- ditional effort to attract consumers and thus incurring additional costs, or it may arise from explicit policies that accompany the price floor policy. The size ofthe deadweightloss depends on the type of non-price rationing mech- anism that defines the new equilibrium 4. The imposition of price ceilings below the equilibrium price results in a dis- equilibrium shortage . In the absence of full price rationing, some non-price rationing mechanism will lead to a new equilibrium, with the size of dead- weight loss again related to the mechanism that emerges.weight loss again related to the mechanism that emerges....
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This note was uploaded on 11/17/2010 for the course ECON 100A taught by Professor Woroch during the Fall '08 term at University of California, Berkeley.
- Fall '08