chap3
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TRANSCRIPT
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MARKET MARKET EFFICIENCY EFFICIENCY
& & ELASTICITYELASTICITY
CHAPTER 3: CHAPTER 3:
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CHAPTER OUTLINE:CHAPTER OUTLINE:
3.1 The Market System
3.2 Market Failure
3.3 Constraint on the Market: Government Intervention
3.4 Market Efficiency & Surpluses Maximization
3.5 Elasticity
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• Stability or equilibrium is a situation when quantity demanded and quantity supplied are equal and there is no tendency for price or quantity to change.Supply = Demand
• Disequilibrium:– The condition that exists in a market when the plans
of buyers do not match those sellers;– A temporary mismatch between quantity supplied
and quantity demanded as the market seeks equilibrium. Supply ≠ Demand
3.1 THE MARKET SYSTEM3.1 THE MARKET SYSTEM
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3.2 MARKET FAILURE3.2 MARKET FAILURE
• Imperfect competition
• Public goods
• Externality/ neighborhood effects
• Imperfect information
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Imperfect CompetitionImperfect Competition
• An industry in which single firm have some control over price & competition. Imperfectly competitive industries give rise to an inefficient allocation of resources.
• Market controlled by monopoly, cartel, illegal co-operation
• Government ownership (Lembaga Air Perak), law & regulation (price control)
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Public GoodsPublic Goods
• Goods or services that are non-rival in consumption and/or their benefits are non-excludable.
• Free-rider problem: because people can enjoy the benefits of public goods whether they pay for them or not, they are usually unwilling to pay them.
• Example: road (transport), hospital (public health), national defense, education.
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Externality/ Neighborhood EffectsExternality/ Neighborhood Effects
• Cost or benefit resulting from some activity or transaction that is imposed or bestowed on parties outside the activity or transaction.
• Example: pollution (cost), chemical usage (cost); a farm located near a city provides resident in the area with nice views and fresher air (benefit).
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• The absence of full knowledge concerning product characteristic, available prices and so fort.
• Adverse selection and moral hazard will occur in the market.
Imperfect InformationImperfect Information
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Imperfect InformationImperfect Information
Adverse Selection
– Occur when a buyer or seller enters into an exchange with another party who has more information
– Example: used car market/ ‘lemon market’• The sellers of used cars have full information about
the real quality of their cars.
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Moral Hazard
– Arises when one party to a contract changes behavior in response to that contract and thus passes on the cost of that behavior change to the other party.
– Example: if my car is fully insured against theft, why should I lock it?
Imperfect InformationImperfect Information
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3.3 CONSTRAINT ON THE MARKET:3.3 CONSTRAINT ON THE MARKET:CASE FOR GOVERNMENT CASE FOR GOVERNMENT
INTERVENTIONINTERVENTION
• Price ceiling• Price floor• Ration coupons• Favored customers• Queuing (waiting in line)• Other restrictions
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Price Ceiling• Government imposed regulations that Government imposed regulations that
prevent prices form rising above a prevent prices form rising above a maximum level set by government. maximum level set by government.
• To control unjust high price (high mark-up price)- E.g: rent control
• Price is set below the equilibrium price, thus will create excess demand (shortage).
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6
5
4
3
2
1
0 2 4 6 8 10 12 14 16 18
Sugar (Kg per week)
Pri
ce (
per
pac
k)
P Qd
RM5
4
3
2
1
2,000
4,000
7,000
11,000
16,000
MarketDemand
200 Buyers
P Qs
RM5
4
3
2
1
12,000
10,000
7,000
4,000
1,000
MarketSupply
200 Sellers
Price Ceiling
7
3
D
S
Price Ceiling
??????????
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Price Floor• Government imposed a regulations that Government imposed a regulations that
prevent prices from falling below a prevent prices from falling below a minimum level set by government.minimum level set by government.
• To adjust unfair low price (price too low). E.g: minimum wage.
• Price is set above the equilibrium price, thus will create excess supply (surplus).
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6
5
4
3
2
1
0 2 4 6 8 10 12 14 16 18
Brown Rice (Kg per week)
Pri
ce (
per
Kg
)
P Qd
RM5
4
3
2
1
2,000
4,000
7,000
11,000
16,000
MarketDemand
200 Buyers
P Qs
$5
4
3
2
1
12,000
10,000
7,000
4,000
1,000
MarketSupply
200 Sellers
Price Floor
7
3
D
S
Price Floor
?????
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• Tickets or coupon that entitle individual to purchase a certain amount for a given per month.
• Everyone would get the same amount
• Example: Introduced rationing of subsidized petrol for target groups.
Ration CouponRation Coupon
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• Those who receive special treatment from dealers during situations of excess demand.
• Example: many gas station owners decided not to sell gasoline to the general public but to reserve their supplies for friends & favored customer.
• Results in hidden costs– Owners changed high prices in service, thus
increased the real price.
Favored Customers
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• Distributing goods & services/ non price rationing mechanism.
• Product cost = cost of waiting
• Example: FBF distributed free ticket for Jay’s concert & student who wait in line can get one ticket for free.– Waiting time imposes a cost on the buyers
(students) of the product (ticket) and provident no benefits to suppliers (FBF).
Queuing (waiting in line)
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• Price control– Production that can only be sell at particular
price by government.– Example: sugar, petrol.
• Licensing/ Permit– Awarding an individual firm exclusive right to
supply the goods and services.– Example: TV signals
Other Restrictions
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Other Restrictions
• Taxes– May be imposed on transactions, institutions,
property, meal & other things but in the final analysis they are paid by individuals/ households.
• Quota– A limit on the quantity of imports from a
country.
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3.4 MARKET EFFICIENCY & SURPLUSUS MAXIMIZATION
• Efficient Market– Pareto Optimality:
• Condition in which no change is possible that will make some members of society better off without hurting some other members of society.
– Simple voluntary change
• Example: I have ‘Principles of Economics’(Mankiw); you have ‘Principle of Economics’ (Case & Fair). My lecturer use Case & Fair while your lecturer use Mankiw. We trade. We both gain and no one losses.
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Consumer and Producer SurplusConsumer and Producer Surplus
• Consumer surplus– The difference between the maximum
amount a person is willing to pay for a good & its current market price (actually pay).
• Producer surplus– The difference between the current market
price and the full cost of production for the firm.
• Extra value producer received.• What producer pay for the right to sell at current
price.2222
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Qo
Quantity (hamburger)
Pri
ce (
per
ham
bu
rger
)
P
Q1
Maximum Combined Surpluses
P1
S
D
ProducerSurplus
ConsumerSurplus
Total Surplus (TS) = Consumer Surplus + Producer Surplus
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Consumer and Producer SurplusConsumer and Producer Surplus
2424
Pri
ce
S
D
Quantity
0
$10987654321
10987654321
Producer Surplus
Consumer Surplus
CS = ½(5x5) = 12.5 =Area of blue triangle
PS = ½(5x5) = 12.5 =Area of red triangle
The combination of producer and consumersurplus is maximized atmarket equilibrium.
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Consumer and Producer SurplusConsumer and Producer Surplus
2525
Pri
ce
S
D
Quantity
0
RM10987654321
10987654321
Producer Surplus:PS = ½ (RM4 x4) + (RM2 x 4) =RM16
If price is RM6,Consumer Surplus: CS = 1/2 (RM4x4) = RM8
Combined consumer and producer surplus decreaseswhen price is above equilibrium.
Deadweight loss = ½(RM2x1) = RM1
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Deadweight Loss
– Losses of consumer and producer surplus that are not transferred to other parties
– Deadweight Loss is the fall in total surplus.
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Cost of Price Ceiling
Price CeilingPrice Ceiling
SS
DD
PricePrice
QuantityQuantityQQ
PP
AA BB
CC DD
EE
QsQs QdQdBefore After Changes
CS ? ? ?
PS ? ? ?
Total Surplus
? ? ?
Deadweight Deadweight Loss: ?? Loss: ??
P*P*
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Cost of Price Floor
Price FloorPrice Floor
SS
DD
PricePrice
QuantityQuantityQ*Q*
P1P1AA
BB CC
DDEE
QdQd QsQsBefore After Changes
CS ? ? ?
PS ? ? ?
Total Surplus
? ? ?
Deadweight Loss: Deadweight Loss: ????
P*P*
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3.5 3.5 ELASTICITYELASTICITY• Definition:
A general concept used to quantify the response in one variable when another variable changes.
• 4 types of elasticity:
(i) Price elasticity of demand (PED)
(ii) Income elasticity of demand (IED)
(iii) Cross price elasticity of demand (CED)
(iv) Price elasticity of supply (PES)
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Price Elasticity of Demand (PED)
• Definition:
PED is a measure of how much the quantity demanded of a good responds to a change in the price of that good.
• Calculating elasticity using two methods:
(i) Formula method
(ii) Midpoint method
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(i) Formula Method:
(ii) Midpoint Method:
100
2/)(
2/)(
12
12
12
12
x
PPPP
QQQQ
PED
1001/)12(
1/)12(x
PPP
QQQPED
Calculating Price Elasticity of Demand (PED)
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Computing the PED Using Formula Method
• Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand would be calculated as:
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
0.220/201002/)0.22.2(
10/)108(
xPED
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Computing the PED Using Midpoint Method
• Example: If the price of an ice cream cone increases from $2.00 to $2.20 and the amount you buy falls from 10 to 8 cones, then your elasticity of demand, using the midpoint formula, would be calculated as:
32.25.9/22100
2/)22.2(0.22.22/)108(
108
xEd
100
2/)(
2/)(
12
12
12
12
x
PPPP
QQQQ
Ed
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• Elimination of minus sign Economist normally ignore the minus sin and present
the absolute value of the elasticity coefficient to avoid an ambiguity.
• Interpretations of PED Economist classify demand curves according to their
elasticity. There are five cases:– Elastic (PED >1)– Inelastic (0< PED <1)– Unitary elasticity (PED =1)– Perfectly elastic (PED = ∞)– Perfectly inelastic (PED = 0)
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The Price Elasticity of Demand: ELASTIC
• PED > 1 (Elastic Demand)
• ∆ in Price < ∆ in quantity
• P↓ (5%) < Qd ↑ (10%)5%5%
10%10%
∆∆PP
DDDD
QuantityQuantity
PricePrice
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The Price Elasticity of Demand: INELASTIC
• PED < 1 (Inelastic Demand)
• ∆ in Price > ∆ in quantity
• P↓ (10%) > Qd ↑ (5%)
5%5%
10%10%
∆∆PP
DDDD
QuantityQuantity
PricePrice
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The Price Elasticity of Demand: UNITARY ELASTIC
• PED = 1 (Unitary Elastic)
• ∆ in Price = ∆ in quantity
• P↓ (10%) = Qd ↑ (10%)
10%10%
10%10%
∆∆PP
DDDD
QuantityQuantity
PricePrice
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The Price Elasticity of Demand: PERFECTLY ELASTIC & PERFECTLY INELASTIC
• PED = ∞ (Perfectly Elastic)
• A situation in which a small percentage change in the price leads to an infinite percentage change in the quantity demanded.
DDDD
QuantityQuantity
PricePrice
5 105 10
1010
DDDD
1010
PricePrice
QuantityQuantity
1010
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• PED = 0 (Perfectly Inelastic)
• A condition in which the quantity demanded does not change even though the price changes.
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Income Elasticity of Demand (IED)Income Elasticity of Demand (IED)
• Definition:– Measures the responsiveness of demand
to changes in income.• Formula:
• Uses:– Positive sign (IED ≥0)
• Normal / luxury goods)– Negative sign (IED < 0)
• Inferior goods
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Cross-Price Elasticity of Demand (CED)Cross-Price Elasticity of Demand (CED)• Definition:
– Measure of the response of the quantity of one good demanded to a change in the price of another good.
• Formula:
• Uses:– Positive sign (CED > 0)• Substitute Product (E.g: butter and margarine)– Negative sign (CED < 0)• Complementary product (E.g: Pen and Ink)
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Price Elasticity of Supply (PES)Price Elasticity of Supply (PES)
• Definition:
– 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.
• FormulaFormula::
pricein change %
suppliedquantity in change % PES
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Price Elasticity of Supply
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Refresh Your Mind
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QUESTION 1:
Use the diagram below to:(i) Calculate total consumer surplus and producer surplus at
the equilibrium price.
(ii) If government imposed price floor at RM11, calculate new producer surplus, consumer surplus and deadweight loss.
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Refer to the figure. Using the midpoint formula, calculate the values of elasticity between points A and B, and then
between points C and D.
QUESTION 2
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