Lecture VII Notes For Sept 21, 2011;

I. Short And Long Run Effects of Specific Tax on Beer

II. Supply and Demand Analysis of Subsidies
III. sing S ! D Analysis in "#dd" $ar%et Situations
I&. #'n(price Elasticity of Demand
&. Income Elasticity of Demand
I. Short ! Long Run Effects of Specific Tax on Beer
A. The market starts out in short and lon run
e!uili"rium at price # $% and !uantit& # '(0 ()packs
*. Assume a speci+ic ta, o+ $2 per ()pack - dra. */T0
short 1 lon run suppl& ross o+ ta, cur2es S
S
3ross
1 S
L
3ross
.
4. In the short run, price ross o+ ta, rises to $5 and
!uantit& +alls to '00 at the intersection o+ S
S
3ross
and 6
S
.
6. In the lon run, e!uili"rium is at the intersection o+
S
L
3ross
and 6 and price # $5.50 .hile 7 +alls to (00.
8. In the short run, ta, re2enue # $29'00: # $1,%00 in
the lon run ta, re2enue # $29(00: # $1,200.
;arket +or ()<acks o+ *eer
$=()pack
S
S
>
S
S
3ross o+ Ta,
S
S
?.00
S
L
3ross o+ Ta,
(.00
S
L
%.00
2.00 6
L
6
S
> 6
S
100 200 @00 %00 500 (00 '00 ?00 A00 ( packs
II. Supply and Demand Analysis of Subsidies
A. ;arket e!uili"rium "eins at 7B, <B
*. Implement a 25 cent su"sid& and suppl& is "ased on
the ross o+ su"sid& suppl& cur2e shi+ted do.n "& 25
cents.
4. Ne. market e!uili"rium is at 7C, <
3ross
, so price to the
consumer +alls +rom <B and !uantit& rises a"o2e the
Doptimum> at 7B
6. Firms et price net o+ su"sid& <
Net
# $0.25E <
3ross
8. 4ost o+ the su"sid& is 0.25B7C, sho.n as a rectanle
on the diaram.
F. Fel+are loss o+ increasin output +rom 7B to 7C is the
trianle sho.n on the diaram.
3. 4onclusionG ;ore is N/T al.a&s "etterH
<roducerCs Share o+ Su"sid& 9trapeIoid a"o2e <B:
Jectanle 9<
Net
)<
3ross
:7Bis S
Net o+ Su"sid&
$=7 Su"sid& 4ost to 3o2ernment
S
3ross o+ Su"sid&
25cents
<
Net/+S
<B
<
3ross
4onsumerCs Share o+ Su"sid& Trianle o+ Fel+are Loss
Is a trapeIoid "elo. <B 1 the 6emand 4ur2e
6
7B 7C 7
III. sing S ! D Analysis in "#dd" $ar%et Situations
A. ;arket +or 1AA( 2intae ca"ernet sa2inon .ine
1. Suppl& cur2e is 2ertical
2. <rice is determined "& the intersection o+
demand .ith the suppl& cur2e.
@. Virtuall& all o+ an& Dta,> is paid "& producers.
This is the one special case in .hich &ou must shi+t the
demand cur2e do.n to et the market price "ecause &ou
canCt shi+t a 2ertical suppl& cur2e up.
*. ;arket +or asoline in 6istrict o+ 4olum"ia
1. 6emand cur2e is horiIontal, 64 small market
2. <rice is determined "& the intersection o+
demand .ith the suppl& cur2e
@. In 1A?0Cs 9under ;a&or *arr&: 64 raised
asoline ta, 10 cents - all asoline stations in 64 shut
%. 200' proposal to eliminate asoline ta, in
;ontomer& 4ount& .ould ha2e KKK e++ectK
I&. #'n()rice Elasticity of Demand
A. Fhat happens to total e,penditure .hen price and
!uantit& chane alon a i2en demand cur2eK
*. /.n <rice 8lasticit& # LM7=LM< #response o+ 7
Inelastic demand, 0N 8 N)1, LMJ has same sin as LM<
8lastic demand, )1 N 8 LMJ has opposite sin as LM<
Onit 8lastic 6emand, )1 # 8, LMJ # 0, LM7 # ) LM<
4. 8lasticit& PTrickP ) Find LMJ 9appro,imatel&:
LMJ LM7 E LM< # 89LM<: E LM< # 98E1:LM<
6. Sample /.n <rice 8lasticit& <ro"lems
1. I+ 8 # )2 and < rises 10L K happens to 7 1 JK
8 # )2 # LM7=10L, so LM7 # )2910L: # )20L
LMJ LM< E LM7 # 10L ) 20L # )10L
2. I+ 8# )0.5 and 7 rises %L K happens to < 1 JK
8 # )0.5 # %L=LM< so LM< # %L=)0.5 # ) ?L
LMJ LM< E LM7 # )?L E %L # )%L
8. 8,treme 8lasticit& 3ames
1. <er+ectl& elastic demand ) horiIontal
2. <er+ectl& inelastic demand ) 2ertical
&. Income Elasticity of Demand
8
I
# L chane in 7=L chane in I # LM7=LMI
A. I+ 8
I
# 1, LM7 # LMI and the +raction o+ income
spent on the ood is constant as income chanes.
*. I+ 8
I
N 1, +raction o+ income spent on ood rises as
income increases and ood is PsuperiorP
4. I+ 8
I
Q 0, e,penditure on ood +alls as income rises
and ood is Pin+eriorP