Week 4 - Equilibrium + Elasticity Flashcards
What is Equilibrium in a Market
Occurs when price balances the buying plans of buyers and selling plans of sellers
How can we see equilibrium on a S/D graph
Where Quantity Demanded = Quantity Supplied
What is Excess Supply
When Market Price > Equilibrium Price
- Q supplied > Q demanded
Implications of Excess Supply
Sellers cannot find buyers for all units supplied to market
What is the pressure from excess supply
Downward pressure on prices as sellers try to bring more consumers into the market
- Q supplied falls in response to decrease in prices
What is Excess Demand
If Market Price < Equilibrium Price
- Q Demanded > Q Supplied
Implications of Excess Demand
Upward pressure on prices, as buyers compete for limited units in market
- Same time Q supplied grows in response to increasing prices
When does Upward/Downwards pressure continue
Until excess supply is eliminated (downward) or excess demand is eliminated (upward)
- Both actions will move market towards equilibrium
Steps to holding an economic analysis (Comparative statics)
1) Start with Market Equilibrium
2) Introduce a ‘shock’ holding all else constant, ceteris paribus
3) Compare before and after
What do we call a micro economic analysis
Partial Equilibrium analysis (focus on single market holding all else constant)
Consumer and firms will only participate in markets if
It is beneficial to them
How can we measure and observe changes in benefits to participants
Welfare Analysis
Key Questions to ask in a Welfare Analysis
1) How happy are you when consume a product?
2) How happy are producers when they sell it?
What is consumer surplus
Difference between what consumers are WTP and what they actually pay (MB - Market Price)
Consumer Surplus on a graph is given by
Area between demand curve and price line up to quantity consumed
Producer surplus is
The amount producers receive (market price) above the minimum price required to make them supply the goods (shown on supply curve MC)
Producer Surplus graphically
Area between the price line and the Supply Curve up to the quantity produced
Equation linking Producer Surplus and Profit
PS = Profit + FC
How to Calculate Total Surplus/Welfare
TS = CS + PS
At equilibrium, the marginal net benefit of producing an additional unit is (why)
0:
- Total net benefits of both consumers and producers
- Sum of CS and PS
CS and PS will be less, losses occur, when we
Overproduce
If more than Q* units are traded, we know that
1) MC > MB
2) Someone is worse off, either buyer paid more than his MB, or seller received a price less than her MB (or both)
If fewer than Q* units are traded
Outcome is not efficient
- Possible to increase the number of units traded in order to make the consumer and/or the producer better off, without making any one worse off
What is Pareto Efficiency
No situation exists where making someone better off doesn’t make someone else worse off
The Pareto Efficient outcome __
Maximises total surplus:
- Outcome is not Pareto efficient if it is possible to reallocate resources and make someone better off without making someone else worse
Outcome in a competitive market is Pareto Efficient
For all the trade up to the competitive market equilibrium (Q*), MB>=MC
- Hence he consumer is willing to pay more than the extra cost required to make the item
- Trading all units until Q0 increases total surplus (increases CS, PS, or both)
Competitive market outcome and efficiency:
Competitive market equilibrium, all the potential gains from trade are exhausted
Effects of Competitive Market and Efficiency
1) No consumers left in market with WTP > Sellers MC to provide an additional unit
2) Importantly, price mechanism ensures that people with highest value for those product end up with the goods (WTP > Market Price) and firms with lowest costs are ones who make the product (firms MC < Market Price)
3) Competitive market manages to maximise TP (reach a Pareto Efficient outcome)
Impacts of Pareto Efficiency
1) Possible that 1+ outcomes in an economy exist
2) Outcome that is Pareto Efficient is not automatically the most fair or equitable - or even desirable
How do we measure how a change in variable affects another
Through Elasticity studies
What is Elasticity
Measures the responsiveness of one variable to another holding all others constant, ceteris paribus
What is elasticity with respect to equilibrium
How does the equilibrium quantity traded responds to a change in the market price, or how does demand respond to changes in a consumers income
Elasticity of y with respect to x is given by
Point = %Change in Y/%Change in X
Midpoint = (without%)Point *(Average of X points)/(Average of Y Points)
2 Ways of Determining Elasticity of 2 variables
1) Point Method (using initial methods)
2) Midpoint Arc Method (Average of initial and final points)
Interpretation of Elasticity in General
At this price, if price of __ (increases/decreases) by 1%, then ___ of __ (increases/decreases) by __%
Negative signs mean in elasticity calculations
Follows the law of demand (take the absolute value)
Elasticity depends on
Slope of Demand Curve, steeper = lower own price of elasticity (ceteris paribus)
Interpretation of Elasticity (abs values)
> 1, demand is elastic
<1, demand is inelastic
=1, demand in unitary elastic
=0, demand is perfectly inelastic
=infinity, demand is perfectly elastic
Why do we use elasticity
Useful to have an understanding because business might be interested in effect of price change on quantity sold, revenue and profits
Price elasticity depends on
Slope of the line and reference point on curve used to calculate elasticity
If slop of demand curve = constant
Elasticity varies because proportional change in quantity (and price) varies depending on size of quantity (or price) @ particular point
Points in every linear demand curve
1) Inelastic section (Q high and P low)
2) Unit elastic (middle of demand curve)
3) Elastic section (Q low and P high)
How to determine elasticity of demand with TR as price changes
TR(P) = P * q(P)
What do we get if we differentiate TR(P) function
Q(1+elasticity(Demand))
What does q(1+elasticity(demand)) show
1) Direct link between price elasticity of demand and change in TR
2) In order for TR to increase with a price increase, RHS > 0
- True iff e>-1, if demand in inelastic
- On other hand, if demand in elastic, e<-1, TR falls if MP rises
3) TR is maximised when demand in unit-elastic, middle of demand curve
Determinants of Price Elasticity of Demand
1) Sustainability with other goods
2) Luxuries vs Necessities
3) Proportion of Income spent on goods
4) Timeframe
Income Elasticity measures __
Responsiveness of change in quantity demanded as change in income, ceteris paribus
Income Elasticity Equations
Point = %Change in Q Demanded/%Change in Income
Midpoint = (No %)Point * (Y0 + Y1)/(Q0 + Q1)
Income Elasticity Interpretation
> 1, income elastic - luxury goods
0-1, income inelastic - Normal goods
<0, negative - inferior good
=0, invariant to changes in income - Neutral good
(Sign tells us about the nature of the good)
Cross-Price Elasticity __
Measures the responsiveness of change in quantity demanded for good X with respect to price of good Y change - ceteris paribus
Cross-Price Elasticity Equations
Point = %Change in Q of X/%Change in P of Y
Midpoint = (without%)Point * (PY0 + PY1)/(QX0 + QX1)
Interpretation of Cross-Price Elasticity
<0 for complementary goods
=0 for independent goods
>0 for substitute goods
Importance of Cross-Price Elasticity
Governments as it plays an impact of taxes on consumer behaviour and important in business for multi-brand product management
What is Price-Elasticity of Supply
Measures the responsiveness of quantity to a change in price of a product, ceteris paribus
Equations of Price-Elasticity of Supply
Point = %Change in Q Supplied/%Change in Price
Implication of Price-Elasticity of Supply
> 0 (follows the law of supply)
1 - Implies Elastic Supply
<1 - Implies Inelastic Supply
=0 - Implies perfectly inelastic supply
=infinity - Implies Perfectly Elastic Supply
