Chapter_5

# Chapter_5 - Summary Chapter 4 Four interventions Price...

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Summary: Chapter 4 Four interventions: Price Ceiling Price Floor Quantity Control Excise Tax In a perfectly competitive market, all of these interventions will lead to some inefficiency. Note that these results only hold in a perfectly competitive market!

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True (A) or False (B)? If the government wants to limit sales of a particular good, it may do so by imposing a quota. However, the same reduction in sales may be achieved by an appropriately chosen excise tax.
True (A) or False (B)? The price that buyers pay and the price that sellers receive in the presence of an excise tax are unaffected by which of these groups officially pays the tax.

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Discussion: 1994 Northridge Earthquake in LA Water supply was not safe, so people had to use bottled water Use supply and demand analysis to show what happens to the price of bottled water. City invoked a state law to prohibit businesses from charging more than 5% extra for certain “essential goods” 30 days after a natural disaster. How do you model this law economically? Should this law be in place? Why or why not?
Chapter 5: Elasticity I. Price Elasticity of Demand I. Impact on Revenue II. Income Elasticity of Demand III. Cross Price Elasticity of Demand IV. Elasticity of Supply V. Elasticity and Tax Incidence

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Price Elasticity of Demand Law of Demand states that as price rises, ceteris paribus, the quantity demanded falls. Elasticity asks: “ by how much ?” Price Elasticity of Demand (E): % Change in Quantity Demanded % Change in Price
q 1 Q p 1 P E = ∞ E = 0 Perfectly Inelastic Demand Q d does not respond at all to changes in P Perfectly Elastic Demand A P increase will cause the Q d to drop to zero . Elasticity Extremes

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E > 1 % change in Q demanded > % change in P A B D P X P 1 P 2 q 1 q 2 Q X Elastic Demand
E<1 % change in Q demanded < % change in P D P X Q X P 1 P 2 q 2 q 1 A B Inelastic Demand

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Calculating Elasticity: the Midpoint Method % Change in Quantity Demanded % Change in Price = % Q D % P % Q D = Q D (Q 1 +Q 2 ) / 2 = Q 2 - Q 1 (Q 1 +Q 2 ) / 2 % P = P (P 1 +P 2 ) / 2 = P 2 - P 1 (P 1 +P 2 ) / 2      (Absolute value of this ratio!)
20 50 Q x 5 P x 4 3 2 1 6 10 30 40 60 \$6x10=\$60 \$3x20=\$60 E = 1 % Change in Q x = % Change in P Unit Elastic

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Review: Price Elasticity of Demand Demand is: – Perfectly inelastic: Q d does not respond at all to changes in price – Perfectly elastic: any price increase will cause the Q d to go to 0 Elastic: E > 1 Inelastic: E < 1
Question 5.1 Calculating PED Vacation Business P 1 = \$200 P 1 = \$200

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Chapter_5 - Summary Chapter 4 Four interventions Price...

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