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UBEA 1013: ECONOMICS
CHAPTER 3: CHAPTER 3: MARKET EFFICIENCY & ELASTICITYMARKET EFFICIENCY & ELASTICITY
3.1 The Market System
3.2 Constraint on the Market: Government Intervention
3.3 Market Efficiency & Surpluses Maximization
3.4 Elasticity
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UBEA 1013: ECONOMICS
DD & SS Interaction
Output (Product) MarketOutput (Product) Market
Utility (excluded)Consumer surplusFactors effect DD
Elasticity
ProductionSupplier surplusFactors effect SS
ElasticityMarket structure
Changes in DD / SS:Equilibrium Price &
Quantity
Microeconomics scope for UBEA 1013 Economics
Market SystemMarket Efficiency
Government Intervention
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UBEA 1013: ECONOMICS
3.1 The Market System3.1 The Market System
Stability or equilibrium point: supply = demand
This situation achieved and re-achieved after disequilibrium through the an important functions of the market (price system):
PRICE RATIONING
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UBEA 1013: ECONOMICS
Price Rationing:Definition: i. Allocates output to consumers and resources to
firms through price adjustment. ii. Price rationing when Qty DD > Qty SS (shortage) iii. Allocation based on willingness & ability to pay
(answering the “for whom to produce” problem).
Figure 3.1: Price Rationing
3.1 The Market System3.1 The Market System
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UBEA 1013: ECONOMICS 3.1 The Market System3.1 The Market System
Note:Price rationing is consider as market oriented approach
because: i. Allocates through open market ii. No government intervention
Weaknesses (market failure): Inability to recognize that each society have the right, necessity or needs to certain type of outputs like health care, accommodation, basic food and safety
Use non-market / non-
pricing approach
lottery approach, political approach and mixed approach
government intervention
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UBEA 1013: ECONOMICS 3.1 The Market System3.1 The Market System
Situations of Market failure:
a) External benefit: i. Free-riders ii. Road (transport), hospital (public health), dam
(flood/electricity)
b) External cost: i. Negative effect/cost to others ii. Pollution
c) Imperfect information: i. Seller has more info than buyer ii. “Lemon market” & info disclosure
d) Imperfect competition: i. Market controlled by monopoly, cartel, illegal co-
operation ii. Government ownership, law & regulation
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UBEA 1013: ECONOMICS
3.2 3.2 Constraint on the Market: Case for Government Intervention
a) Price ceiling: i. Maximum price sellers may charge ii. To control unjust high price
iii. Excess demand (Ration coupon as complement action to control DD)iv. Emerging of black market
Figure 3.1 (Price Ceiling at $3.27)
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UBEA 1013: ECONOMICS
b) Ration coupon: i. Ticket/coupon entitle individual to purchase ii. Coupons trading – alike price rationing
iii. Serve as redistributing income
3.2 Government Intervention3.2 Government Intervention
c) Favored customer: i. Special treatment ii. Results in hidden cost
d) Waiting in line (Queuing): i. Product cost = cost of waiting ii. A form of deadweight loss
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UBEA 1013: ECONOMICS
e) Price floor: i. Minimum price for buying – selling ii. To adjust unfair low price
iii. Excess of supply (government has to buy up excess)iv. Alternative: subsidization
Figure 3.2: Price Floor: Minimum Wages
f) Other restriction: i. Price control ii. Licensing
iii. Taxesiv. Quota
3.2 Government Intervention3.2 Government Intervention
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UBEA 1013: ECONOMICS
3.3 3.3 Market Efficiency & Surpluses Maximization
What is “Efficient Market”?:
i. Pareto efficient: A market is efficient if there is no way to make any person better off without hurting anybody else. (Relate to PPF)
ii. Relate to PPF: Reduce production of product “Y” to increase production of product “X”.
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UBEA 1013: ECONOMICS
What is “Consumer Surplus”?: i. Extra value individual received ii. What people willing to pay
iii. Maximum amount willing to pay minus current market price
3.3 Efficiency & Surpluses3.3 Efficiency & Surpluses
Figure 3.3: Consumer Surplus
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UBEA 1013: ECONOMICS
What is “Producer Surplus”?: i. Extra value producer received ii. What producer pay for the right to sell at current
priceiii. Minimum amount willing to sell minus current market price
3.3 Efficiency & Surpluses3.3 Efficiency & Surpluses
Figure 3.4: Producer Surplus
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UBEA 1013: ECONOMICS 3.3 Efficiency & Surpluses3.3 Efficiency & Surpluses
Surplus maximization:
i. Market efficient = maximize sum of consumer & producer surpluses
ii. Achieved when DD = SS
Figure 3.5(a): Surplus maximization
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UBEA 1013: ECONOMICS
Deadweight loss: i. Losses of consumer and producer surplus that are
not transferred to other parties ii. Occur from under and over production
Figure 3.5(b): Deadweight loss (under production)
Figure 3.6: Deadweight loss (over production)
3.3 Efficiency & Surpluses3.3 Efficiency & Surpluses
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UBEA 1013: ECONOMICS
3.4 3.4 Elasticity
A measure of how “responsive” demand is to some change in price or income:
i. The slop of a demand function (∆q/∆p) ii. The slope of the demand curve (∆p/∆q)
iii. Elasticity method
2 3 1slope
10 5 5
2 3 1
slope160 80 80
Figure 3.5(a): Demand Curve Slope & Responsiveness
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Elasticity is a general concept to:
i. quantify the response in one variable when another variable changes
ii. measure the percentage change in one variable brought about by a 1 percent change in some other variableiii. Elasticity is unit free
Type of elasticity: i. Price elasticity of demand ii. Income elasticity
iii. Cross-price elasticity
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Price elasticity of demand calculation: How responsive consumers are to changes in the price of a product
ε = [(∆q/q)*100%] / [(∆p/p)*100%] ………… (Equation 3.1)
= (∆q/q)*100% * (p/∆p)*(1/100%)
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)
Ratio of price to quantity
multiply
Slope of demand function
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Example: Use Figure 3.7 (a) & (b). Assumed price decrease from P1 = $3 to P2 = $2.
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2) = (3/5)*[(10 – 5)/(2 – 3)] = – 3
or
For Figure 3.7 (a):
Same answer for Figure 3.7 (b): proving that different unit of measurement did not effect elasticity.
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
BUT different answer if assumed price increase from P1 = $2 to P2 = $3.
Solution: Mid-point formula
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
NOTE: Which one is more elastic?
– 5 – 4 – 3 – 2 – 1
More elastic Less elastic
1 2 3 4 5
Less elastic More elastic
In absolutevalue
In negativevalue
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Figure 3.8(a): Perfectly Inelastic Figure 3.8(b): Perfectly Elastic
Table 3.1 shows values & types for elasticity of demand
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Elasticity of linear demand curve: i. Change from point to point ii. Decrease when move downward
iii. Elastic at upper range, inelastic at lower range
Figure 3.9: Elasticity of a Linear Demand Curve
At middle point, elasticity = 1
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Calculus proving (No. 1):
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2) = (p/q)* (– b) = [p / (a – bp)]* [– b] (›› q = a – bp)
– 1 = [p / (a – bp)]* [– b] (unitary elasticity)– 1 = (– bp) / (a – bp) bp = (a – bp)2bp = a p = a / 2b (middle point)
Consider a linear demand curve, q = a – bp i. The slope = – b ii. If q = 0; p = a / b (price intercept)
p = a / b
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Calculus proving (No. 2):
p = a / b
Linear demand curve, q = a – bp At price axis intercept, q = 0 & p = a / b
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2) = [(a/b) / 0]* (– b) = ∞ (›› infinity elasticity at price intercept)
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Calculus proving (No. 3):
p = a / b
Linear demand curve, q = a – bp At quantity axis intercept, p = 0 & q = a
ε = (p/q)*(∆q/∆p) …………… (Equation 3.2) = (0/a)*(– b) = 0 (›› zero elasticity at qty intercept)
a
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Price increase > Qty drop›› increase price = increase revenue
Price increase < Qty drop›› increase price = reduced revenue
Price increase = Qty drop›› revenue maximization
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Cross price elasticity: Measure of the response of the quantity of one good demanded to a change in the price of another good
ε = [(∆q/q)*100%] / [(∆p’/p’)*100%]
For substitute product: ε(p’) positive (the price of one product and
quantity demanded for another product move in the same direction)
For complement product: ε(p’) negative (the price of one product
and quantity demanded for another product move in the opposite direction)
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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity
Elasticity of labor supply is a measure of the response of labor supplied to a change in the price of labor
Elasticity of supply is a measure of the response of quantity of a good supplied to a change in price of that good. Its value is likely to be positive in output markets due to the law of supply.
Others elasticity:
End