Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Understanding Economics 5th...

Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved.

Understanding Economics5th edition

by Mark Lovewell

Chapter 3Competitive Dynamics and

Government


Learning ObjectivesAfter this chapter, you will be able to:

1. comprehend price elasticity of demand, its relation to other demand elasticities, and its impact on sellers’ revenues

2. understand the price elasticity of supply and the links between production periods and supply

3. identify how price elasticities of demand and supply determine the impact of an excise tax on consumers and producers

4. explain how governments use price controls to override the “invisible hand” of competition


Elastic and Inelastic Demand (a) Price elasticity of demand shows how

responsive consumers are to price changes.elastic demand means % change in quantity

demanded is more than % change in priceinelastic demand means % change in quantity

demanded is less than % change in priceunit-elastic demand means % change in quantity

demand equals % change in price


Elastic and Inelastic Demand (b)Figure 3.1 Page 58


Elastic Demand Curvefor Ice Cream Cones

0 500 1000

0.40

0.80

1.20

1.60

2.00

2.4020%

50%

20%

10%

D1 D2

Quantity Demanded(cones per winter month)

Pri

ce (

$ p

er c

on

e)

Inelastic Demand Curvefor Ice cream Cones

0.40

0.80

1.20

1.60

2.00

2.40

0 500 1000

Quantity Demanded(cones per summer month)

Pri

ce (

$ p

er c

on

e)

1800 2000

Perfectly Elastic and Perfectly Inelastic Demand (a) Perfectly elastic demand means a constant

price and a horizontal demand curve. Perfectly inelastic demand means a constant

quantity demanded and a vertical demand curve.


Perfectly Elastic and Perfectly Inelastic Demand (b) Figure 3.2 Page 59


Perfectly ElasticDemand Curvefor Soybeans

0

1.60 D3

Quantity Demanded(tonnes)

Pri

ce (

$ p

er t

on

nes

)

Perfectly InelasticDemand Curvefor Insulin

0 1000

Quantity Demanded(litres)

Pri

ce (

$ p

er t

on

nes

)

D4

Total Revenue and the Price Elasticity of Demand (a) A price change causes total revenue to

change in the opposite direction when demand is elastic.

A price change causes total revenue to change in the same direction when demand is inelastic.

A price change does not affect total revenue when demand is unit-elastic.


Revenue Changes with Elastic Demand Figure 3.3 Page 60


Demand Curve for Videos

1

2

3

4

5

0 500 1000

Quantity Demanded (videos rented each day)

Pri

ce (

$ to

ren

t a

vid

eo)

1500

A

B C

D

Revenue Changes with Inelastic Demand Figure 3.4 Page 61


Demand Curve for Amusement Park Rides

1

2

3

4

5

0 2000 6000 10 000

E

F GD

4000 8000

Quantity Demanded (riders each day)

Pri

ce (

$ p

er r

ide)

Total Revenue and the Price Elasticity of Demand (b) Figure 3.5 Page 62


Demand Elasticity and Changes in Total Revenue

Elastic Demand

Inelastic Demand

Unit-Elastic Demand

PriceChange

updown

updown

updown

Change inTotal Revenue

downup

updown

unchangedunchanged

Determinants of the Price Elasticity of Demand There are four determinants:

portion of consumer incomes (products with smaller portions more inelastic)

access to substitutes (products with more substitutes more elastic)

necessities versus luxuries (more inelastic for necessities and more elastic for luxuries)

time (more elastic with the passage of time)


Calculating Price Elasticity of DemandA numerical value for price elasticity of

demand (ed) is found by taking the ratio of the changes in quantity demanded and in price, each divided by its average value.

In mathematical terms:ed = ΔQd ÷ average Qd

Δprice ÷ average price


Elasticity and a Linear Demand Curve (a)A linear demand curve has a different price

elasticity (ed) at every point.At high prices, the change in quantity

demanded (price) is relatively large (small) relative to average quantity demanded (price), giving a large ed.

At low prices, the change in quantity demand (price) is relatively small (large) relative to average quantity demanded, giving a small ed.


Elasticity and a Linear DemandCurve (b) Figure 3.6 Page 64


0 1 2 3

Quantity Demanded(millions of sodas)

Market Demand Curve for Sodas

Pri

ce (

$ p

er s

od

a)

1

2

3

4

5

Market Demand Schedulesfor Sodas

5

4

3

2

1

0

0

1

2

3

4

5

9.00

2.33

1.00

0.43

0.11

Price

($ per soda)

4

PriceElasticity

of Demand(ed)

QuantityDemanded

(millions of sodas)

5ed > 1

ed = 1

ed < 1

Income ElasticityIncome elasticity (ei) is the responsiveness of

a product’s quantity demanded to changes in consumer income.

In mathematical terms:ei = ΔQd ÷ average Qd

ΔI ÷ average I


Cross-Price ElasticityCross-price elasticity (ei) is the

responsiveness of the quantity demanded of one product (x) to a change in price of another (y).

In mathematical terms:exy = ΔQd ÷ average Qd

ΔPy ÷ average Py


Elastic and Inelastic Supply Price elasticity of supply measures the

responsiveness of quantity supplied to price changes.Elastic supply means % change in quantity

supplied is more than % change in price.Inelastic supply means % change in quantity

supplied is less than % change in price.


Elastic and Inelastic SupplyFigure 3.7, Page 67


Elastic Supply Curvefor Tomatoes

0 100 000 120000

1

2

3

4S1

Quantity Supplied(kilograms per year)

Pri

ce (

$ p

er k

ilo

gra

m)

0

Inelastic Supply CurveFor Tomatoes

100 000 120 000

Quantity Supplied(kilograms per year)

Pri

ce (

$ p

er k

ilo

gra

m)

1

2

3

4S2

50% 50%

100% 20%

Perfectly Elastic and Perfectly Inelastic Supply Perfectly elastic supply means a constant

price and a horizontal supply curve. Perfectly inelastic supply means a constant

quantity supplied and a vertical supply curve.


Time and the Price Elasticity of Supply (a) Price elasticity of supply changes over three

production periods:Supply is perfectly inelastic in the immediate

run.Supply is either elastic or inelastic in the short

run.Supply is perfectly elastic for a constant-cost

industry and very elastic for an increasing-cost industry in the long run.


Time and the Price Elasticity of Supply (b) Figure 3.8, Page 68 (continued in part (e))


Immediate-RunSupply Elasticityfor Strawberries

0

S1

Quantity Supplied(kilograms per month)

Pri

ce (

$ p

er k

ilo

gra

m)

S2

750 000 0

Short-RunSupply ElasticityFor Strawberries

11

Quantity Supplied(millions of kilograms per year)

Pri

ce (

$ p

er k

ilo

gra

ms) 2.50

2.00

9

Time and the Price Elasticity of Supply (c)If strawberries are produced in a constant-

cost industry:A higher price of strawberries raises

production but not resource prices.As new businesses enter the industry in the

long run due to a higher price of strawberries, this price is gradually pushed back down to its original level.

Therefore the long-run supply curve for a constant-cost industry is perfectly elastic.


Time and the Price Elasticity of Supply (d)If strawberries are produced in a increasing-

cost industry:A higher price of strawberries raises

production and also resource prices.As new businesses enter the industry in the

long run due to a higher price of strawberries, this price is gradually pushed back down to its lowest possible level, but this level is higher than it was originally.

Therefore the long-run supply curve for an increasing-cost industry is very elastic.


Time and the Price Elasticity of Supply (e) Figure 3.8, Page 68 (continued from part (b))


Long-Run Supply Elasticity

0

Quantity Supplied(millions of kilograms per decade)

Pri

ce (

$ p

er k

ilo

gra

ms)

S32.00

S4Constant-cost Industry

Increasing-cost Industry

Calculating Price Elasticity of SupplyA numerical value for price elasticity of

supply (es) is found by taking the ratio of the changes in quantity supplied and in price, each divided by its average value.

In mathematical terms:es = ΔQs ÷ average Qs

Δprice ÷ average price


Excise Taxes (a)An excise tax is a tax on a particular product

expressed as a dollar amount per unit of quantity.

Such a tax creates a new supply curve (S1) seen by consumers. It is vertically above the initial supply curve (S0) seen by producers.The reason for this difference is that the price

as seen by consumers is now higher than that seen by producers.


Excise Taxes (b)The after-tax price for consumers is found

where S1 crosses the demand curve. The after-tax equilibrium price for producers is the corresponding price on S0.The total tax paid by consumers is found by

multiplying their tax-induced price rise by after-tax quantity.

Similarly, the total tax paid by consumers is found by multiplying their corresponding price drop by after-tax quantity.


The Impact of an Excise TaxFigure 3.9, page 71


S1

a

d

A

B(millions of tonnes)

QuantitySupplied

QuantityDemanded

(D) (S0)

579

1113

1311975 0

S0

D

Market Demand and SupplyCurves For Strawberries

Price

($ per tonne)

3.00 2.50 2.00 1.50 1.00

0.50

3.00

2.50

2.00

1.50

1.00

3.50

1 3 5 7 9 11 13 15

Quantity (millions of kg per year)

Pri

ce (

$ p

er k

g)

The Impact of an Excise Tax

4.00

c

(S1)

975 3 1

b

$1

The Effect of ElasticityFor a given supply curve, the more elastic the

demand curve the greater the proportion of an excise tax paid by producers.

For a given demand curve, the more elastic the supply curve the greater the proportion of an excise tax paid by consumers.


Excise Taxes and Demand Elasticity Figure 3.10, page 72


S0

D

c

2.75

1.75

a

d

A

B

2.25

1.25

A

Bd

a

86

2.00 2.00

9


Pri

ce (

$ p

er k

g)

Inelastic Demand

Pri

ce (

$ p

er k

g)

9

Elastic Demand


S0

D

c

S1S1

b

$1

b

$1

Excise Taxes and Supply ElasticityFigure 3.11, page 73


2.00 2.00

9


Pri

ce (

$ p

er k

g)

Inelastic Supply

9

Elastic Supply


cc

S0

D

S0

D

2.25

1.25

Pri

ce (

$ p

er k

g)

b

b$1

$1

8

S1

a2.75

1.75

6

d

A

B

A

d

B

S1

a

Price Controls A price floor is a minimum price set above the

equilibrium price.It results in a surplus in the market.

A price ceiling is a maximum price set below the equilibrium price.It results in a shortage in the market.


Agricultural Price Supports Price supports for agricultural goods are an

example of a price floor.They help overcome unstable agricultural

prices.Farmers win from these supports.Consumers and taxpayers lose from these

supports.


Reasons for Price SupportsFigure 3.12, page 74


Market Demand and SupplySchedules for Wheat

(millions of tonnes)

Price

($ per tonne)

QuantitySupplied

QuantityDemanded

(D) (S0) (S1)

$140 120 100 80 60

1011121314

1413121110

121110 9 8

20

120

100

80

60

40

140

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Quantity (millions of tonnes per year)

0

Pri

ce (

$ p

er t

on

ne)

Market Demand and SupplyCurves for Wheat

S1 S0

D

a

b

Effects of Price SupportsFigure 3.14, page 76


0 58 59 60

Quantity(millions of litres per year)

Market Demand and Supply Curves for Milk

Pri

ce (

$ p

er li

tre)

.70

.90

1.10

1.30S

D

62

surplusMarket Demand and Supply

Schedules for Milk

$1.30

1.10

0.90

60

59

61

60

62

58

(millions of litres)

Price($ per litre)

A price floorcreates

a surplus.

61

QuantitySupplied

(S)

QuantityDemanded

(D)

Rent Controls Rent controls are an example of a price

ceiling.They keep down prices of controlled rental

accommodation.Some (especially middle-class) tenants win

from these controls.Other (especially poorer) tenants lose from

these controls.


Effects of Rent ControlsFigure 3.15, page 77


0

Quantity(units rented per month)

Market Demand and SupplyCurves for Units

Pri

ce (

$ p

er u

nit

)

300

500

700S

D

Market Demand and SupplySchedules for Units

$700

500

300

2000

1700

2300

2000

2500

1500

(units rented per month)

Price($ rent

per month)

A price ceilingcreates

a shortage.

1500 2000 2500

shortage

2300

QuantitySupplied

(S)

QuantityDemanded

(D)

Prophet of Capitalism’s Doom According to Karl Marx’s theory of

exploitation:a product’s price is based on the amount of

labour that goes into producing itcapitalists cut costs by minimizing workers’

wages and by maximizing the length of the workday

capitalists keep any surplus value, which is the excess of their revenues over their costs


Marx’s Theory of ExploitationFigure A, Page 84


$30$50

Creation of Surplus Value

0

80

Daily Wage

Va

lue

pro

du

ce

d (

$ p

er

da

y)

20

40

60

Creation of Surplus Value(when producing 2 shirts or 1 suit)

Daily Wage

Materials andmachine wearand tear (M)

Surplus Value (SV)

Total Value

Exploitation Rate

(SV/W)

$50 Wage

$50

$10

$20

$80

2

5

$30 Wage

$30

$10

$40

$80

4

3

W = 50

M = 10

SV = 10 SV = 40

W = 10

W = 30

The Economic Role of Government

Besides intervening in private markets, Canadian governments have an independent role.

Government programs include payments to adults with children, retirement funds for the elderly, unemployment insurance, welfare, higher education subsidies, free health care and schooling, and subsidized public housing.


Federal Spending The main federal spending programs are:

transfer payments to seniors (the Seniors Benefit)

tax credits to low-income parents (the Child Tax Credit)

transfer payments to the unemployed (Employment Insurance)

pensions (the Quebec and Canada Pension Plans)


Provincial and Territorial SpendingThe responsibilities of provincial and

territorial governments include:health caresubsidies for post-secondary educationwelfare services

The federal government pays a portion of these costs through the Canada Health and Social Transfer (CHST).


Government ExpendituresFigure A, Page 87


Goods and servicesTransfers to

PersonsBusinessesNonresidentsProvinces and local

Debt charges

58.2

75.93.84.4

55.931.5

229.8

Federal (2006)($ billions)


PersonsBusinessesGovernments

Debt charges

186.1

38.29.8

47.328.3

309.7

Provincial (2006)($ billions)


PersonsBusinessesProvinces

Debt Charges

98.2

3.21.70.13.6

106.8

Local (2006)($ billions)

Taxation (a)Canadian governments use five main types of

taxation:Personal income taxes are levied by both

federal and provincial governments, and are based on four marginal federal tax rates (15%, 22%, 26%, and 29%).

Sales taxes are levied by both federal and provincial governments, and are charged as a percentage of price on a wide range of products.


Taxation (b)Excise taxes are levied by both federal and

provincial governments, and are usually charged as a dollar amount per unit of quantity on particular products.

Property taxes are charged by local governments on buildings and land.

Corporate income taxes are paid by corporations to both federal and provincial governments as a percentage of annual profits.


Tax Revenues for All Levels of Government (2006)Figure B, Page 88


Personal income taxesSales and excise taxesProperty taxesCorporate income taxesMiscellaneous taxes

Percent of Gross Domestic

Product

12.1 9.3 2.9 3.6 5.2

33.1

Percent ofTotal Taxes

36.328.28.8

10.915.7

100.0

Government Taxes and the Canadian Economy Figure C, Page 88


Debates over Government’s Role (a)

Taxes have increased significantly as a proportion of the total Canadian economy over the past few decades.

Critics argue that taxes and some spending programs reduce productive activity.

Critics also contend that many government programs are inequitable, and hampered by administrative problems.


Debates Over Government’s Role (b)

Supporters of government admit that public spending and taxation are not as effective as they could be. But they argue that these problems need to be seen in perspective, given that private markets are also subject to a variety of flaws.


Chapter 3The End


Date post:	19-Dec-2015
Category:	Documents
Upload:	osborn-gibson
View:	224 times
Download:	2 times

Copyright © 2009 by McGraw-Hill Ryerson Limited. All rights reserved. Understanding Economics 5th...

Documents