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Section 2
Diagrams and Definitions
A market is any situation or place that enables the buying and selling of goods and services and factors of production. A market may be a physical location (a street market), it may also be a virtual one (internet buying and selling) or a national one (the market for teachers or doctors). Triple A
Markets exist when buyers and sellers interact. This interaction determines market prices and thereby allocates scarce good and services.
What is a market?
Demand
A schedule (curve) that shows the quantity of a good that consumers are able and willing to buy at a certain price during a specified period of time.
Change in Quantity Demanded
Law of Demand
Determinants of Demand: Price
Determinants of Demand: Non-price
Determinants of Demand
Change in Demand
Movements versus Shifts
Change in Quantity DemandedChange in Demand
Veblen Goods
Giffen Goods
Expectations
Supply
A schedule (curve) showing how much of a product producers will supply at each of a series of prices over a specific period of time.
Law of Supply
Why Does Supply Rise when Price Rises?
I can make more profit!
Determinants of Supply: Price
Change in Quantity Supplied
Determinants of Supply: Non-price
Determinants of Supply
Change in Supply
Movements Versus Shift
Change in Quantity Supplied Change in Supply
Equilibrium
Consumer and Producer Surplus
Consumer Surplus
Price
Quantity
D
Po
Qo
A + B = Maximum Willingness to Pay for Qo
What is paid
Consumer Surplus
A
B
Minimum Amount Needed to Supply Qo
Producer Surplus
Price
Quantity
Po
Qo
What is paid
Producer Surplus
S
Consumer and Producer Surplus
Price
Quantity
Po
Qo
S
Producer Surplus
Consumer Surplus
D
Original Consumer Surplus
Change in Consumer Surplus: Price Increase
Quantity
New Consumer Surplus
Loss in Surplus: Consumers paying more
Loss in Surplus: Consumers buying less
Price
D
Po
Qo
P1
Q1
Price Ceilings
Price Floor
Price Ceiling & Price Floor
Price Support/Buffer Stock Schemes
Governments intervene when there are extreme price fluctuations brought about by seasons factors (agricultural products) and/or economic factors (commodities).
Loss in Efficiency Too High a Price (Price Floor)
Price
Quantity
Po
Qo
S
D
QL
New Consumer Surplus
PH
New Producer Surplus
Lost Consumer Surplus
Lost Producer Surplus
Price Floor
New Producer Surplus
New Consumer Surplus
Loss in Efficiency Too Low a Price (Price Ceiling)
Price
Quantity
Po
Qo
S
D
QL
PL
Lost Consumer Surplus
Lost Producer Surplus
Price Ceiling
ElasticitiesPrice
elasticity of
demand PED
Cross elasticity
of demand
XED
Income elasticity
of demand
YED
Price elasticity of supply
PES
Price Elasticity of Demand (PED)
P rice e las tic ity o f d em an d =P ercen tag e ch an g e in q u an tity d em an d ed
P ercen tag e ch an g e in p rice
Range of PED values
Price Inelastic Demand
Price Elastic Demand
Range of PED
Extreme Cases
Perfectly Elastic Demand
Perfectly Inelastic Demand
Unit Elastic Demand
Determinants of PED
Determinants of PEDIncome
Determinants of PESTime
Determinants of PESSpare Capacity
Impact on Total Revenue of Firms
• Total revenue is the amount paid by buyers and received by sellers of a good. TR = P x Q
• With an inelastic demand curve, an increase in price leads to a decrease in quantity that is proportionately smaller. Thus, total revenue increases.
• With an elastic demand curve, an increase in price leads to a increase in quantity that is proportionately smaller. Thus, total revenue decreases.
• Governments levy taxes to raise revenue for public projects
• Critics of taxation argue that:– Taxes discourage market activity.– When a good or service is taxed, the
quantity sold is smaller.
Taxation
Indirect Tax Specific Tax
Indirect Tax Ad Valorem Tax
• Tax incidence is the manner in which the burden of a tax is shared among participants in a market.
• How this burden is shared depends on elasticity.
Tax Incidence
Tax and Relatively Inelastic Demand
Tax and Relatively Inelastic Demand
Price for Buyers = .35
Price for Sellers= .2 (150m X .2)
(150m X .15)
(150m X .35)
Tax and Relatively Inelastic Demand
Price for Buyers = .35
Price for Sellers = .25
Before Tax Buyers paid .25After Tax Buyers pay .35 Buyers contribute 15 m to Revenue (150 X .1)
Tax and Relatively Elastic Demand
Summary
• The incidence of a tax refers to who bears the burden of a tax.
• The incidence of a tax does not depend on whether the tax is levied on buyers or sellers.
• The incidence of the tax depends on the price elasticities of supply and demand.
• The burden tends to fall on the side of the market that is less elastic.
Total Revenue and Price Elastic Demand
Total Revenue and Price Inelastic Demand
Some Practical Applications of PED
• With an elastic demand curve, an increase in the price leads to a decrease in quantity demanded that is proportionately larger. Thus, total revenue decreases.
Theory of the Firm The Goal
• Provide advice • about the following:• The best price• The best output• The most profit• To breakeven price• The shutdown price
Variable Costs (VC)are the focus as Fixed Costs (FC)cannot change in the short term.
Ways to Measure Output
The Total Product Curve
Average and Marginal Product Curves
Diminishing Average Returns
Diminishing Marginal Returns
Total Costs (TC) = total cost to produce a certain output. TC = TFC + TVC
Total Variable Costs (TVC) = total
cost of the variable assets
that a firm uses in a given period of
time.
Total Fixed Costs (TFC) = total cost
of fixed assets used in a given time period.
Total Fixed Costs (TFC)
Total Variable Costs (TVC)
Total Costs
TC
Average Fixed Costs
(AFC)
Average Variable
Costs (AVC)
Average Total Costs
(ATC)Marginal
Cost (MC) = increase in
TC of producing an extra unit of output
TFC, TVC and TC
Cost Curves
LRAC A firm altering all its factors to meet increasing
demand
Economies and Diseconomies of Scale
Economies and Diseconomies of Scale
Economies of Scale
Specialization
Bulk Buying of Inputs
Financial Savings
Transport Savings
Technology
Advertising and
promotion
Diseconomies of Scale
Control and Communication
Alienation/work satisfaction
Total Revenue
Marginal Revenue
Revenue Curves: Perfectly Elastic Demand
5
Price
Output
D=AR=MR
Accounting Profit
Economic Profit
Determining the Shut Down Price and the Break Even
Price
Shut Down Price
Profit Maximizing Level of Output
Profit Maximizing Level of Output with Perfectly Elastic
Demand
Profit Maximizing Level of Output with Normal Demand
Profit Maximizing Level of Output with Normal Demand
Normal Profit Normal Demand
Abnormal Profit Normal Demand
Loss Normal Demand
Is it alw
ays a
bout p
rofit?
Profit, Sales and Revenue Maximization?