contentsclange/ · contents 3 11 government interventions81 11.1 price controls. . . . . . . . . ....
TRANSCRIPT
Contents
1 Introduction 4
2 Equations, Diagrams, and other Tools 52.1 How Diagrams Explain Economic Laws . . . . . . . . . . . . . . . . 62.2 How Equations Explain Economic Laws . . . . . . . . . . . . . . . 102.3 How Equations are Related to Diagrams . . . . . . . . . . . . . . . 122.4 Discovering Economic Laws with Regression Analysis . . . . . . . . 132.5 Different Ways to Calculate Quantitative Change . . . . . . . . . . 142.6 Videos, Simulations, and other Internet Resources . . . . . . . . . . 152.7 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 16
3 Markets 173.1 Competitive Markets . . . . . . . . . . . . . . . . . . . . . . . . . 183.2 Monopoly Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . 193.3 Oligopoly Markets . . . . . . . . . . . . . . . . . . . . . . . . . . . 203.4 Other Market Types . . . . . . . . . . . . . . . . . . . . . . . . . . 213.5 Videos, Simulations, and other Internet Resources . . . . . . . . . . 223.6 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 23
4 Introduction to the Demand Concept 244.1 Determinants of Demand . . . . . . . . . . . . . . . . . . . . . . . 254.2 Relationship between Demanded Quantity and Price . . . . . . . . . 264.3 Demand Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . 274.4 Shifts of the Demand Curve . . . . . . . . . . . . . . . . . . . . . 284.5 Demand Equation . . . . . . . . . . . . . . . . . . . . . . . . . . 294.6 Change of the Demand Equation . . . . . . . . . . . . . . . . . . 304.7 Videos, Simulations, and other Internet Resources . . . . . . . . . . 314.8 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 33
5 Introduction to the Supply Concept 345.1 Determinants of Supply . . . . . . . . . . . . . . . . . . . . . . . . 355.2 Supplied Quantity and Price . . . . . . . . . . . . . . . . . . . . . 365.3 Supply Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 375.4 Shifts of the Supply Curve . . . . . . . . . . . . . . . . . . . . . . 38
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CONTENTS 2
5.5 The Supply Equation . . . . . . . . . . . . . . . . . . . . . . . . . 395.6 Change of the Supply Equation . . . . . . . . . . . . . . . . . . . . 405.7 Videos, Simulations, and other Internet Resources . . . . . . . . . . 415.8 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 43
6 Aggregating Individuals’ and Firms’ Demand and Supply 446.1 Aggregating Individuals’ and Firms’ Demand and Supply Curves . . 456.2 The Effect of Market Entrance and Exit on Market Demand and
Supply Curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 466.3 Aggregating Individuals’ and Firms’ Demand and Supply Equations 476.4 The Effect of Market Entrance and Exit on Market Demand and
Supply Equations . . . . . . . . . . . . . . . . . . . . . . . . . . . 486.5 Videos, Simulations, and other Internet Resources . . . . . . . . . . 49
7 Equilibrium Concept and Economic Analysis 507.1 Finding an Equilibrium in a Demand and Supply Diagram . . . . . . 517.2 Effects of Shifting Demand and Supply Curves on the Equilibrium . 527.3 Calculating Equilibrium Price and Quantity . . . . . . . . . . . . . 537.4 Calculating Changes of Equilibrium Price and Quantity . . . . . . . 547.5 Videos, Simulations, and other Internet Resources . . . . . . . . . . 557.6 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 57
8 Economic Analysis Using the Demand-Supply Concept 58
9 Elasticity 599.1 Elasticity - Definition, Measurement, and Differences with Slope . . 609.2 Price Elasticity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61
9.2.1 Price Elasticity of Demand . . . . . . . . . . . . . . . . . . 619.2.2 Price Elasticity of Supply . . . . . . . . . . . . . . . . . . . 619.2.3 How Price Elasticity Impacts Price and Quantity Changes . . 61
9.3 Income Elasticity of Demand . . . . . . . . . . . . . . . . . . . . . 629.3.1 Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . 629.3.2 Normal and Inferior Goods . . . . . . . . . . . . . . . . . . 62
9.4 Cross Price Elasticity of Demand . . . . . . . . . . . . . . . . . . . 639.4.1 Definition . . . . . . . . . . . . . . . . . . . . . . . . . . . 639.4.2 Substitutes and Complements . . . . . . . . . . . . . . . . 63
9.5 Videos, Simulations, and other Internet Resources . . . . . . . . . . 649.6 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 73
10 Measuring Welfare 7410.1 Consumer Surplus Concept . . . . . . . . . . . . . . . . . . . . . . 7510.2 Producer Surplus Concept . . . . . . . . . . . . . . . . . . . . . . . 7610.3 Measuring Welfare in a Competitive Market . . . . . . . . . . . . . 7710.4 Short Comings of the Consumer-Producer Surplus Concept . . . . . 7810.5 Videos, Simulations, and other Internet Resources . . . . . . . . . . 7910.6 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 80
CONTENTS 3
11 Government Interventions 8111.1 Price Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8211.2 Effect of Taxation on Equilibrium Price and Quantity . . . . . . . . 8611.3 Consumers’ and Producers’ Tax Burden . . . . . . . . . . . . . . . 8911.4 Welfare Effects of a Tax . . . . . . . . . . . . . . . . . . . . . . . . 92
11.4.1 Dead-Weight Loss and the Laffer Curve . . . . . . . . . . . 9411.5 Videos, Simulations, and other Internet Resources . . . . . . . . . . 9711.6 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 98
12 Deriving Individual Demand from Preferences 99
13 Deriving Firm Supply from Cost of Production 10013.1 Types of Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10113.2 Graphical Representation of Cost Types . . . . . . . . . . . . . . . 10213.3 Optimal Production Quantity in a Competitive Market . . . . . . . 10313.4 Deriving the Short Run Supply Curve for a Competitive Market . . . 10413.5 Deriving the Long Run Supply Curve for a Competitive Market . . . 10513.6 Videos, Simulations, and other Internet Resources . . . . . . . . . . 10613.7 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 107
14 Monopoly 10814.1 Profit Maximizing . . . . . . . . . . . . . . . . . . . . . . . . . . . 109
14.1.1 Conditions for a Profit Maximum . . . . . . . . . . . . . . . 10914.1.2 Deriving the Monopolist’s Profit Maximum in a Market Di-
agram . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10914.2 Welfare Effects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11014.3 Monopolistic Competition . . . . . . . . . . . . . . . . . . . . . . . 11114.4 Price Discrimination . . . . . . . . . . . . . . . . . . . . . . . . . . 11214.5 Videos, Simulations, and other Internet Resources . . . . . . . . . . 11314.6 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 114
15 Oligopoly 11515.1 Profit Maximization in a Duopoly . . . . . . . . . . . . . . . . . . . 11615.2 A Game Theory Approach . . . . . . . . . . . . . . . . . . . . . . . 11715.3 Videos, Simulations, and other Internet Resources . . . . . . . . . . 11815.4 End of Chapter Questions . . . . . . . . . . . . . . . . . . . . . . . 119
Chapter 1
Introduction
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Chapter 2
Equations, Diagrams, andother Tools
Author: Carsten Lange
This chapter will introduce tools and techniques that help to analyze economicproblems. These tools and techniques are used throughout the book. You will learnhow graphs in diagrams as well as equations can represent economic laws. Youwill see that a function in a diagram is just another representation of an economiclaw and you will learn how empirical data can be used to derive an economiclaw resulting in either a graph or an equation. Since economic variables changeover time, it is also important to measure the change of an economic variable suchas income. Change of an economic variable can be calculated in various ways andthe most common ways to calculate change are covered in this Chapter. Thisincludes absolute change of an economic variable, relative (percentage) changeof an economic variable, and the so called midpoint formula as a way to measurepercentage change.
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CHAPTER 2. EQUATIONS, DIAGRAMS, AND OTHER TOOLS 6
2.1 How Diagrams Explain Economic Laws
Author: Carsten Lange
A graph in a diagram can be used to represent an economic law. This is bestexplained by an example that uses a well known fact in economics:
The higher the income1 of a person is, the more the person consumes.
If Figure 2.1 represents the law that connects income with consumption for a personnamed Anne, then we can find out for each of Anne’s potential incomes what herconsumption would be.
Figure 2.1: The Relation Between Income and Consumption for a Specific Consumer(with numbered axes)
If Anne had an income of $60,000, how can we find how much she wouldconsume according to the income-consumption law presented by the graph? Wefirst find an income of $60,000 at the income axis (horizontal axis) and then movestraight up (this ensures that income does not change) until we reach the graph,which presents the economic behavior/law we are interested in.2 From the pointon the graph we move horizontally (this ensures that the consumption level doesnot change) to the left to find the answer Anne’s consumption at the vertical axis:
11It would be more precise to use the disposable income, which is income minus tax, but fornow we want to keep things simple and just talk about a persons income in general.
2This sounds trivial since there is only one graph, but in economics we often use diagramswith more than one graph and then it is important to use the correct graph that represents theeconomic law we are interested in.
CHAPTER 2. EQUATIONS, DIAGRAMS, AND OTHER TOOLS 7
labeled Consumption: Anne would consume for $50,000, if she had an income of$60,000. The same way we could find out consumption levels for all incomes coveredby the graph. E.g., an income of $160,000 would create consumption for $130,000.
The arrows in Figure 2.1 suggest that we start at the horizontal axes. Whichraises the question, if it is import at which axis we start our argumentation. Theanswer is yes! Since the axis we start and the axis we end determines the directionof causation. Here the income (at the horizontal axis) causes the consumptionlevel (at the vertical axis) and not the other way around! Wouldn’t it be nice, if ahigher consumption automatically leads to a higher income, but this unfortunatelyonly happens in our dreams. Consequently, in our example we have to start at thehorizontal axis because income causes consumption and not the other way around.Most of the times the variable that causes the other variable (independent variable;here: income) is shown at the horizontal axis and the variable that is caused bythe independent variable (dependent variable; here: consumption) is shown at thevertical axis. Unfortunately, economists do not always follow this rule and we willsee already in Chapters 4 and 5 exceptions of this rule when the demand and supplydiagrams are discussed.
Figure 2.2: The Relation Between Income and Consumption for a Specific Consumer(without numbered axes)
At this point it should be clear that the diagram in Figure 2.1 is very useful to
CHAPTER 2. EQUATIONS, DIAGRAMS, AND OTHER TOOLS 8
describe Anne’s consumption behavior as we can choose any income and find outhow much Anne would consume. However, in economics diagrams similar to theone shown in Figure 2.2 are more common. This diagram is essentially the sameas the one in Figure 2.1 except that it does not show numbers ($-amounts) at theaxis. You might ask, what is a diagram good for, if it does not have numbers at theaxis? Let’s give the diagram in Figure 2.2 a chance to tell its story. We start sameway as we started we started in Figure 2.1 by choosing an income level of interest.We choose the income level that is labeled Y0. Although the horizontal axis inFigure 2.2 does not show $-amounts we know that a $-amount would be assignedto Y0, if there were numbers. As before we move straight up starting at Y0untilwe reach the graph and then we move horizontally to the left until we reach thevertical axis at a point C0. Again, if there were numbers, a consumption $-amounthad been assigned to C0. Therefore, we can summarize that if Anne had an incomeof Y0(dollars) she would consume C0(dollars). We admit that this information isnot very useful. But it becomes useful, if we look at another potential income ofAnne, the income that is represented by Y1. We again go straight up to the graphand then move horizontally to the left until we reach the vertical axis at point C1.Analog to the income/consumption pair labeled with a Y0/C0, we can now saythat if Anne has an income of Y1she will consume C1. Although not obvious, thisprovides valuable information and here is why:
The $-amount behind Y1 must be higher than the one behind Y0. This isbecause Y1is further to the right than Y0and consequently represents a higher income(remember: on the horizontal axis of a diagram we find the large numbers towardsthe right while we find the small numbers to the left). Now we know that an increasein income from Y0to Y1will lead to a change in consumption from C0to C1. We alsoknow that the dollar amount behind C1is bigger than the one behind C0, becauseC1is located higher on the vertical axis than C0(larger numbers are further up onthe vertical axis than lower ones). If we summarize what we found so far, we getan important result about Anne’s behavior.
If Anne’s income increases (from Y0 to Y1), then Anne’s consumptionwill increase (fromC0to C1).
Now not having numbers at the axis in Figure2.2 becomes an advantage rather thana disadvantage. Because the economic law stated above is not based on specific$-amounts, we can generalize the law and state that any increase in Anne’s incomewill lead to an increase in Anne’s consumption. If we now add the assumption thatAnne is a typical person (we will call this later an representative economic agent)we can state the law derived from Figure 2.2 more general:
If an economic agent’s income increases, then we assume that her/hisconsumption will increase.
Thus the diagram in Figure 2.2 represents an economic law from which we believeit is true. The law shows the behavior of consumers, when income changes. If wecombine the graph in this diagram with other graphs, we can combine assumptionsabout economic agents and then draw conclusions on how this affects economic
CHAPTER 2. EQUATIONS, DIAGRAMS, AND OTHER TOOLS 9
variables. We will do this in Chapter 7 when we analyze how demand and supplybehavior (each represented by one graph) together can determine the price in amarket.
CHAPTER 2. EQUATIONS, DIAGRAMS, AND OTHER TOOLS 10
2.2 How Equations Explain Economic Laws
Author: Carsten Lange
Instead of expressing Anne’s behavior in a diagram we can also use an equation.As there were two types of diagrams in Section 2.1, we can distinguish two typesof equations — specific equations and general equations. Similar to the diagramtypes the first equation type uses numbers, while the second one is more generaland uses parameters instead. The equation
Ci = 0.8Yi + 2000 (2:1)
shows Anne’s consumption behavior in the same way as Figure 2.1 did. We canchoose potential incomes for Anne and find out Anne’s consumption level. Forexample, if Anne had an income of $60,000, her consumption would be:
Ci = 0.8 60, 000 + 2000 = 50, 000
This is the same consumption level we derived for an income of $60,000 whenusing Figure 2.1 and this is not only true for an income of $60,000. It is also truefor any income we choose. Let’s try an income of $160,000.
Ci = 0.8 160, 000 + 2000 = 130, 000
Again, the results derived from equation (2:1) match the results derived fromFigure 2.1. This is because the equation and the graph both describe Anne’s be-havior. In fact we can derive the graph from the equation and vice versa (seeSection 2.3). This means a graph and an equation can express the same law. It isjust as using another language to describe the same fact. However, as we usuallydo not have enough information to express an economic behavior exactly by using adiagram with numbered axes, we do not usually have enough information to expresseconomic behavior with a specific equation such as equation (2:1). Instead we usea more generalized type of equation. For example:
Ci = mYi + b withm > 0 (2:2)
What can we derive from this equation? First, we can see that the consumptionlevel is determined by the sum of two parts. The first part (mYi) is influencedby the income, while the second part is not. In fact the second part (b) showsthe influence of all other factors on consumption – except income. The influenceof these factors combined can either be positive or negative. Therefore b also canbe positive or negative. Although in most cases we do not know what the exactaccumulated influence of all these factors on consumption is, we assume it is atleast constant. This is called the ceteris paribus condition. Ceteris paribus isLatin and means everything else equal. Note, that it says everything else ratherthan everything. This raises the question, what is allowed to change and what
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needs to be held equal? The answer is that the variables we analyze are allowed tochange, while everything else is not allowed to change. Otherwise, the law that wederived would not hold anymore. In our case income and consumption are allowedto change while everything else is held equal/constant including the parameters man b in equation (2:2).
In Section (2.1) we were able to derive an economic law from the generalizeddiagram (no numbers at the axis) and we can derive exactly the same economic lawfrom equation (2:2). We look at both parts that determine consumption (mYiandb). Obviously, the second part (b) cannot help us a lot, since we do not even knowif it is positive or negative. But the first part (mYi) can help. If we look carefullyat mYi we can see that every income $-amount we use will be multiplied with thesame positive number. Consequently, if income increases, a larger number will bemultiplied with m and the first part of the equation (mYi) becomes bigger. Sincethe second part does not change the right hand side of equation (2:2) becomesbigger meaning that consumption (Ci) which is determined by the right hand sideof equation (2:2) becomes bigger. In short:
If an economic agent’s income increases, then we assume that her/hisconsumption will increase.
Again, the generalized form of the equation and the generalized form of the diagramexpress the same economic behavior. Again, the diagram uses just a different way(a different language if you like) to express the same behavior than the equation.
In order to find out how an economic variable on the right hand side of abehavioral equation influences the variable that is explained, we can use the followingshortened procedure: Look at the parameter (m in our case) in front of the variablewhose influence you want to analyze (Yi in our case). Then find out if the parameteris positive or negative. If it is negative it means, whenever the analyzed variableincreases, the variable on the left hand side of the equation will decrease. If itis positive (like in our case), whenever the analyzed variable increases, so will thevariable on the left hand side of the equation.
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2.3 How Equations are Related to Diagrams
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2.4 Discovering Economic Laws with Regression Anal-ysis
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2.5 Different Ways to Calculate Quantitative Change
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CHAPTER 2. EQUATIONS, DIAGRAMS, AND OTHER TOOLS 15
2.6 Videos, Simulations, and other Internet Resources
Instructional Videos
Each video covers a selected concept of content.
For Section: 2.1 How Diagrams Explain Economic Laws
How to use a Diagram that has no Numbered Axisby Carsten Lange
Shows how an economic law or behavior can be displayed in a diagram. It also usesan example on how to use such a diagram.Click here to start ID:2 Click here to rate
How to use a Diagram that has a Numbered Axisby Carsten Lange
Shows how an economic law or behavior can be displayed in a diagram. It also usesan example on how to use such a diagram.Click here to start ID:3 Click here to rate
Short Videos
Short videos provide students with five minutes videos about key techniques andconcepts. In order to keep the videos short, only the most important aspects are cov-ered. However, the topics covered are techniques and concepts that many studentsstruggle with.
Diagrams and Economic Laws, Part 2by Carsten Lange
The video explains how to work with a diagram such as a demand diagram. It alsopoints out why each graph in a in a diagram represents an economic law. Part 2covers diagrams without numbered axis. This type of diagram is very comon ineconomics and many students struggle with its interpretation.Click here to start ID:28 Click here to rate
Diagrams and Economic Laws, Part 1by Carsten Lange
The video explains how to work with a diagram such as a demand diagram. It alsopoints out why each graph in a in a diagram represents an economic law. Part 1covers diagrams with numbered axis.Click here to start ID:29 Click here to rate
CHAPTER 2. EQUATIONS, DIAGRAMS, AND OTHER TOOLS 16
2.7 End of Chapter Questions
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Chapter 3
Markets
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CHAPTER 3. MARKETS 18
3.1 Competitive Markets
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3.2 Monopoly Markets
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3.3 Oligopoly Markets
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3.4 Other Market Types
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3.5 Videos, Simulations, and other Internet Resources
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Key Terms to Remember
Find an explanation of important key terms on the Internet.
For Section: 3 Markets
Introduction to Marketsby Wikipedia
Gives a basic definition of a market.Click here to start ID:1 Click here to rate
Instructional Videos
Each video covers a selected concept of content.
For Section: ?? Competitive Markets
Introduction to the Analysis of Marketsby Carsten Lange
Defines markets and their functions and explains simplifying assumptions commonlymade in market analysis.Click here to start ID:4 Click here to rate
Price Determinationby Carsten Lange
Explains why price must be jointly explained by supply and demand and gives anexample for how prices are determined in a competitive market.Click here to start ID:6 Click here to rate
CHAPTER 3. MARKETS 23
3.6 End of Chapter Questions
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Chapter 4
Introduction to the DemandConcept
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CHAPTER 4. INTRODUCTION TO THE DEMAND CONCEPT 25
4.1 Determinants of Demand
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4.2 Relationship between Demanded Quantity andPrice
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4.3 Demand Curve
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4.4 Shifts of the Demand Curve
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4.5 Demand Equation
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4.6 Change of the Demand Equation
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CHAPTER 4. INTRODUCTION TO THE DEMAND CONCEPT 31
4.7 Videos, Simulations, and other Internet Resources
Instructional Videos
Each video covers a selected concept of content.
For Section: 4.1 Determinants of Demand
Individual Demand Basicsby Carsten Lange
Covers the basic determinants of demand and explains normal versus inferior andsubstitute versus complementary goods.Click here to start ID:7 Click here to rate
For Section: 4.2 Relationship between Demanded Quantity and Price
Quantity Demanded and Individual’s Responses to Priceby Carsten Lange
Defines ”quanty demanded” and explains how individual’s demand responds to price.Click here to start ID:8 Click here to rate
For Section: 4.3 Demand Curve
Demand Curve Derivation Basicsby Carsten Lange
Covers the derivation of a demand curve using a class experiment for coke demandat varying price levels.Click here to start ID:5 Click here to rate
The Law of Demandby Carsten Lange
Explains the law of demand as the inverse relationship between price and quantityand show how this is reflected in a downward-sloping demand curve.Click here to start ID:9 Click here to rate
For Section: 4.4 Shifts of the Demand Curve
CHAPTER 4. INTRODUCTION TO THE DEMAND CONCEPT 32
Shifts in the Demand Curveby Carsten Lange
Explains shifts in demand versus changes in quantity demanded and differentiatesbetween direct and indirect determinants of demand.Click here to start ID:12 Click here to rate
CHAPTER 4. INTRODUCTION TO THE DEMAND CONCEPT 33
4.8 End of Chapter Questions
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Chapter 5
Introduction to the SupplyConcept
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CHAPTER 5. INTRODUCTION TO THE SUPPLY CONCEPT 35
5.1 Determinants of Supply
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CHAPTER 5. INTRODUCTION TO THE SUPPLY CONCEPT 36
5.2 Supplied Quantity and Price
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CHAPTER 5. INTRODUCTION TO THE SUPPLY CONCEPT 37
5.3 Supply Curve
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CHAPTER 5. INTRODUCTION TO THE SUPPLY CONCEPT 38
5.4 Shifts of the Supply Curve
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CHAPTER 5. INTRODUCTION TO THE SUPPLY CONCEPT 39
5.5 The Supply Equation
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CHAPTER 5. INTRODUCTION TO THE SUPPLY CONCEPT 40
5.6 Change of the Supply Equation
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5.7 Videos, Simulations, and other Internet Resources
Instructional Videos
Each video covers a selected concept of content.
For Section: 5.1 Determinants of Supply
Basic Determinants of Supplyby Carsten Lange
Gives an overview of direct and indirect determinants of supply (price, cost, etc).Click here to start ID:13 Click here to rate
For Section: 5.2 Supplied Quantity and Price
The Law of Supplyby Carsten Lange
Explains the law of supply and individual rationale in choosing quantity supplied.Also covers derivation of individual and market supply curves.Click here to start ID:14 Click here to rate
For Section: 5.3 Supply Curve
Quantitative Approach to Deriving Market Supplyby Carsten Lange
Explains how to derive market supply from individual supply curves using a quanti-tative example in Excel.Click here to start ID:15 Click here to rate
For Section: 5.4 Shifts of the Supply Curve
Shifts in the Supply Curveby Carsten Lange
Reviews the determinants of supply, lists shifters of supply, and explains how to usesupply if the price changes.Click here to start ID:16 Click here to rate
CHAPTER 5. INTRODUCTION TO THE SUPPLY CONCEPT 42
Short Videos
Short videos provide students with five minutes videos about key techniques andconcepts. In order to keep the videos short, only the most important aspects are cov-ered. However, the topics covered are techniques and concepts that many studentsstruggle with.
For Section: 5.2 Supplied Quantity and Price
The Law of Suppy - Why does a price increase increases production?by Carsten Lange
The video explains in an intuitive way, why costs are crucial to explain that priceincreases for a good usually leads to more production in a market. This is alsorefered to as the Law of Supply.Click here to start ID:30 Click here to rate
CHAPTER 5. INTRODUCTION TO THE SUPPLY CONCEPT 43
5.8 End of Chapter Questions
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Chapter 6
Aggregating Individuals’ andFirms’ Demand and Supply
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CHAPTER 6. AGGREGATING INDIVIDUALS’ AND FIRMS’ DEMAND AND SUPPLY 45
6.1 Aggregating Individuals’ and Firms’ Demand andSupply Curves
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CHAPTER 6. AGGREGATING INDIVIDUALS’ AND FIRMS’ DEMAND AND SUPPLY 46
6.2 The Effect of Market Entrance and Exit on Mar-ket Demand and Supply Curve
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CHAPTER 6. AGGREGATING INDIVIDUALS’ AND FIRMS’ DEMAND AND SUPPLY 47
6.3 Aggregating Individuals’ and Firms’ Demand andSupply Equations
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CHAPTER 6. AGGREGATING INDIVIDUALS’ AND FIRMS’ DEMAND AND SUPPLY 48
6.4 The Effect of Market Entrance and Exit on Mar-ket Demand and Supply Equations
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CHAPTER 6. AGGREGATING INDIVIDUALS’ AND FIRMS’ DEMAND AND SUPPLY 49
6.5 Videos, Simulations, and other Internet Resources
Instructional Videos
Each video covers a selected concept of content.
For Section: 6.1 Aggregating Individuals’ and Firms’ Demand and Supply Curves
Deriving a Market Demand Curveby Carsten Lange
Walks through an empirical approach (classroom example) to deriving market de-mand from individual demand, using Excel.Click here to start ID:11 Click here to rate
Market Demandby Carsten Lange
Covers differentiation between individual and market demand, how to aggregateindividual demand into market demand, and how to derive a demand schedule fromsample data.Click here to start ID:10 Click here to rate
Chapter 7
Equilibrium Concept andEconomic Analysis
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50
CHAPTER 7. EQUILIBRIUM CONCEPT AND ECONOMIC ANALYSIS 51
7.1 Finding an Equilibrium in a Demand and SupplyDiagram
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CHAPTER 7. EQUILIBRIUM CONCEPT AND ECONOMIC ANALYSIS 52
7.2 Effects of Shifting Demand and Supply Curveson the Equilibrium
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CHAPTER 7. EQUILIBRIUM CONCEPT AND ECONOMIC ANALYSIS 53
7.3 Calculating Equilibrium Price and Quantity
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CHAPTER 7. EQUILIBRIUM CONCEPT AND ECONOMIC ANALYSIS 54
7.4 Calculating Changes of Equilibrium Price andQuantity
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CHAPTER 7. EQUILIBRIUM CONCEPT AND ECONOMIC ANALYSIS 55
7.5 Videos, Simulations, and other Internet Resources
Instructional Videos
Each video covers a selected concept of content.
For Section: 7.1 Finding an Equilibrium in a Demand and Supply Diagram
Market Equilibriumby Carsten Lange
Covers how prices are determined at equilibrium price and quantity, as well as theadaptation (”invisible hand”) process.Click here to start ID:17 Click here to rate
For Section: 7.2 Effects of Shifting Demand and Supply Curves on the Equilibrium
Market Equilibrium in Changing Market Conditionsby Carsten Lange
Uses the supply and demand diagram to analyze changes in market conditionsutilizing a ”five-step” approach.Click here to start ID:18 Click here to rate
Short Videos
Short videos provide students with five minutes videos about key techniques andconcepts. In order to keep the videos short, only the most important aspects are cov-ered. However, the topics covered are techniques and concepts that many studentsstruggle with.
For Section: 7.1 Finding an Equilibrium in a Demand and Supply Diagram
Finding Demanded and Supplied Quantities in a Market Equilibrium Diagram, Part 1by Carsten Lange
The video helpd students to find demanded and supplied quantities simultaneouslyfor a given price in a market diagram. This skill is important for many applicationsincluding price ceilings and floors as well as stability analysis of an equilibrium. Thevideo provides a step by step approach to find and compare supplied and demandedquantities. Part 1 uses a diagram with numbered axis.Click here to start ID:31 Click here to rate
CHAPTER 7. EQUILIBRIUM CONCEPT AND ECONOMIC ANALYSIS 56
Equilibrium and Stability - Why can we be so sure that most markets reach the equilibrium price and quantity?by Carsten Lange
The videos shows briefly how stuents can find an equilibrium in a diagram. After-wards, two examples are used to show that markets tend to reach the equilibrium.This is important to understand, because performing analysis with demand and sup-ply diagrams becomes much easier when we can assume that a market reaches itsequilibrium by itself.Click here to start ID:33 Click here to rate
CHAPTER 7. EQUILIBRIUM CONCEPT AND ECONOMIC ANALYSIS 57
7.6 End of Chapter Questions
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Database.
Chapter 8
Economic Analysis Using theDemand-Supply Concept
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58
Chapter 9
Elasticity
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59
CHAPTER 9. ELASTICITY 60
9.1 Elasticity - Definition, Measurement, and Dif-ferences with Slope
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CHAPTER 9. ELASTICITY 61
9.2 Price Elasticity
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9.2.1 Price Elasticity of Demand
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9.2.2 Price Elasticity of Supply
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9.2.3 How Price Elasticity Impacts Price and Quantity Changes
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CHAPTER 9. ELASTICITY 62
9.3 Income Elasticity of Demand
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9.3.1 Definition
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9.3.2 Normal and Inferior Goods
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CHAPTER 9. ELASTICITY 63
9.4 Cross Price Elasticity of Demand
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9.4.1 Definition
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9.4.2 Substitutes and Complements
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CHAPTER 9. ELASTICITY 64
9.5 Videos, Simulations, and other Internet Resources
Instructional Videos
Each video covers a selected concept of content.
For Section: 9 Elasticity
Elasticity and Its Applicationby Carsten Lange
Defines price elasticity and differentiates between elastic and inelastic goods.Click here to start ID:24 Click here to rate
For Section: 9.2 Price Elasticity
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
CHAPTER 9. ELASTICITY 65
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
CHAPTER 9. ELASTICITY 66
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
CHAPTER 9. ELASTICITY 67
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
CHAPTER 9. ELASTICITY 68
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
CHAPTER 9. ELASTICITY 69
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
CHAPTER 9. ELASTICITY 70
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
Price Elasticity and Revenuesby Carsten Lange
Explains the interrelation between price elasticity and revenues when quantity ischanged.Click here to start ID:26 Click here to rate
CHAPTER 9. ELASTICITY 71
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Supplyby Carsten Lange
Defines price elasticity of supply and gives some circumstances under which it maybe low or high. Cross-price and income elasticityClick here to start ID:27 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
CHAPTER 9. ELASTICITY 72
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Price Elasticity of Demandby Carsten Lange
Explains why price elasticity of demand is always negative and shows how to measureprice elasticity when quantity demanded changes, both quantitatively and diagra-matically. Also shows under which circumstances price elasticity is low or high andgives some important ranges for elasticity of demand.Click here to start ID:25 Click here to rate
Short Videos
Short videos provide students with five minutes videos about key techniques andconcepts. In order to keep the videos short, only the most important aspects are cov-ered. However, the topics covered are techniques and concepts that many studentsstruggle with.
For Section: 9.1 Measuring Slope vs. Elasticity
Calculating Percentage Change - Traditional Formula vs. Midpoint Formulaby Carsten Lange
The video demonstrates the shortcomings of calculating percentage change with thetraditional fomula taught in highschool. Then it introduces the midpoint formula forcalculating percentage change as an alternative that overcomes these shortcomings.Click here to start ID:35 Click here to rate
CHAPTER 9. ELASTICITY 73
9.6 End of Chapter Questions
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Chapter 10
Measuring Welfare
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CHAPTER 10. MEASURING WELFARE 75
10.1 Consumer Surplus Concept
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CHAPTER 10. MEASURING WELFARE 76
10.2 Producer Surplus Concept
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CHAPTER 10. MEASURING WELFARE 77
10.3 Measuring Welfare in a Competitive Market
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CHAPTER 10. MEASURING WELFARE 78
10.4 Short Comings of the Consumer-Producer Sur-plus Concept
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CHAPTER 10. MEASURING WELFARE 79
10.5 Videos, Simulations, and other Internet Re-sources
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CHAPTER 10. MEASURING WELFARE 80
10.6 End of Chapter Questions
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Chapter 11
Government Interventions
Author: Craig Kerr
In previous chapters, we have observed that perfectly competitive markets maxi-mize total welfare without any outside influence from governments. In this chapter,we will look at how perfectly competitive markets are affected by two tools govern-ments have at their disposal, price controls and taxes. By the end of the chapter,the reader should understand:
1. How price controls affect welfare and the allocation of goods and servicesin competitive markets (see Section 11.1).
2. How taxes affect welfare and the allocation of goods and services in com-petitive markets (see Sections 11.2 and 11.4)..
3. That it does not matter whether producers or consumers are taxed whenconsidering the tax burden, welfare, or the allocation of goods and services incompetitive markets (see Section 11.3).
4. What determines how the tax burden is shared between consumers andproducers (see Section 11.3).
81
CHAPTER 11. GOVERNMENT INTERVENTIONS 82
S
D
1 2 2.5 6Q
4
5
6
P
Figure 11.1: Non-Binding Ceiling
11.1 Price Controls
Author: Craig Kerr
The prices of gasoline vary widely over time. During periods of rising gasolineprices, it is common to see news reporters interviewing disgruntled consumers atthe pump. Invariably, at least one consumer suggests that the government shouldput a cap on gasoline prices. Would such a limit really help consumers? How woulda price ceiling effect the allocation of gasoline?
price ceilling - maximum price that may be legally charged.Suppose the market for gasoline is perfectly competitive and can be described
by the equations
P = 6 −QD
and
P = 2QS
where quantity is in millions of gallons. If the federal government put a $5 priceceiling on gasoline, how much gasoline would be demanded? How much gasolinewould be supplied? What would the price be?
Figure 11.1 depicts the market for gasoline. The equilibrium price is $4 a gallonand the equilibrium quantity is 2 million gallons. Therefore, when the governmentdeclares charging over $5 to be illegal, nothing there is no change as the price isalready below $5. This is what is known as a non-binding price ceiling becausethe constraint of P ≤ $5 does not bind any agent’s behavior.
What happens when the price ceiling is set below equilibrium price at $3? As youcan see in Figure 11.2, the price ceiling is now binding as it changes the behavior ofsome consumers and producers. Producers are only willing to sell 1.5 million gallonsat a price of $3 whereas consumers now wish to purchase 3 million gallons. The
CHAPTER 11. GOVERNMENT INTERVENTIONS 83
D
S
1.5 2 3 6Q
4
3
6
P
Figure 11.2: Binding Ceiling
price ceiling has created a 1.5 million gallon shortage (excess demand). Not onlyare consumers not able to purchase the 3 million gallons they desire at the currentprice, they cannot even purchase the 2 million they were previously consuming.
A binding price ceiling results in a shortage of goods and services. In reality,this can lead to black markets or secondary markets. Any consumer that is able topurcahse gasoline for $3 may buy as much as he can and resell it to his neighbor for$4 making a $1 a gallon profit. Without a price ceiling, no neighbor would purchasegasoline for a price higher than market price. However, with a binding price ceilingmany consumers are unable to purchase gasoline in the market due to the shortageand may have to purchase gasoline on secondary markets at higher prices.
A government can also declare a legal minimum on prices. This is called a pricefloor. An example of a price floor in labor services in the minimum wage. Justlike a price ceiling, a price floor can be binding or non-binding. Suppose the marketfor unskilled labor is perfectly competitive in a city and can be described by theequations
P = 20 −QD
and
P = 5 + QS
where quantity is in thousands of workers and the price is the hourly wage.If the federal government imposed a $10 minimum wage, it would not bind as the
equilibrium wage (price of labor services) is $12.50 as seen in Figure 11.3. Since allconsumers of labor services (employers) are paying $12.50, the federal governmentdeclaring that all employers must pay at least $10 will not change anything asemployers already are.
However, if a minimum wage of $15 were imposed, the price floor would bindand result in a shortage as observed in Figure 11.4. Since a $15 minimum wageis more than what employers are currently paying, there will be employers who are
CHAPTER 11. GOVERNMENT INTERVENTIONS 84
D
S
7.5 20Q
5
1012.5
P
Figure 11.3: Non-binding Price Floor
not willing or able to pay minimum wage and quantity demanded decreases to 5.On the other hand, more suppliers of labor services (workers) will be willing to selltheir services at $15 an hour, increasing quantity supplied to 10 thousand workers.Therefore, there is a surplus (excess supply) of 5 thousand workers, which in thelabor market is referred to as unemployement.
While the 5 thousand workers now receiving $15 an hour clearly benefit fromthis minimum wage, 5 thousand workers who previously had jobs paying $12.50 anhour now are unemployed. In addition, the workers between 7.5 and 10 thousandare now willing to supply their labor and actively seek jobs but are not employed.
A binding price floor creates an over-supply of goods and services. In the exampleabove, too many workers are supplying their labor searching for employement whenthey could be doing other things like attending school or spending time at home.If the market in question were a goods market, too much of the good would beproduced as all producers would attempt to obtain the artificially higher price butnot all would be able to sell their products.
CHAPTER 11. GOVERNMENT INTERVENTIONS 85
5 7.5 10 20Q
5
1512.5
P
Figure 11.4: Binding Price Floor
CHAPTER 11. GOVERNMENT INTERVENTIONS 86
11.2 Effect of Taxation on Equilibrium Price andQuantity
Author: Craig Kerr
In this world nothing can be said to be certain, except death and taxes.- Benjamin Franklin
Most governments impose taxes on their constituents. When a recent college grad-uate receives his first paycheck, he may find that the federal government takesaround 17.5% of his wages!1 With the money he has left after paying taxes, he willmake additional small payments to the government every time he purchases goodsor services through sales tax. If he uses a portion of his earnings to purchase stocksand/or bonds, he will again pay taxes if he sells the asset at a profit.
Taxes are practically unnavoidable payments made to governmets for the purposeof funding the services they provide or to redistribute wealth among the population.The money collected by governments are used to pave roads, employ police andfiremen, maintain parks, and provide many other public goods. The tax you areprobably most familiar with is the sales tax, which is a percentage of the price paidfor a good or service.
In this chapter, we will consider a tax on the quantity of goods or servicespurchased. The federal gasoline tax is an example of a quantity tax. In 2014, everygallon of gasoline was taxed $0.184. The amount of the tax does not change withthe price, only the quantity purchased.
Let us look at how the federal gasonline tax effects the market for gasoline. Wewill assume that the market is perfectly competitive and, for ease of calculation,that the tax is $2 a gallon. Although the consumer sees the tax in the price at thepump, the gas station owner is the one who actually pays the tax to the government.How does the tax affect the owner’s behavior?
Suppose the market for gasoline is perfectly competitive and can be describedby the supply and demand equations
P = 1 +1
5QS
P = 8 − 1
5QD,
which are displayed in Figure 11.5 by the solid lines and quantity is in millions ofgallons. The supply curve has an intercept at $1, meaning that the price of gasolinemust be at least $1 before any gas station will supply a positive amount of gasoline.If the gas stations must now pay $2 to the government for every gallon the sell,they would only be willing to sell gasoline for an extra $2 a gallon. That is, gasstations must now receive at least $1 + $2 = $3 per gallon before they are willingto supply a positive amount of gasoline.
1Assuming a salary of $55,000 in 2014 for a single filer.
CHAPTER 11. GOVERNMENT INTERVENTIONS 87
This increase in the minimum willingness to accept means that the supply curvewill shift up by $2 at every quantity. Mathematically, this means we add $2 tothe right hand side of our supply eqution. Note that we do this when the supplyequation is solved in terms of P . If our supply equation was in terms of Q and weadded 2, we would be adding a quantity of 2, which is not a dollar amount.
The equation for supply with a tax of $2 per gallon is then
P = 2 + 1 +1
5QS
P = 3 +1
5QS
and the new equilibrium price with the tax is $5.50. The introduction of a tax onproducers causes supply to shift left (or up), which results in a shortage (excesssupply) of 10 million gallons of gasonline . This puts upward pressure on price untilthe market reaches a new equilibrium at $5.50 a gallon.
Notice that the price did not increase by the amount of the tax as we mightinitially expect. This is due to the Law of Demand. Since the price of gasonlineincreases with a tax, quantity demanded decreases, here from 17.5 million to 12.5million gallons. Therefore, when a government introduces a quantity tax in a com-petitive market, the equilibrium price will increase and the equilibrium quantity willdecrease. Since the government receives $2 per gallon and 12.5 million gallons aresold, the tax revenue collected by the government is $25 million.
ST
S
D
7.5 12.5 17.5 40Q
1
3
4.55.5
8
P
Figure 11.5: Gasoline in CA
In the example above, we looked at a quantity tax on producers. But what if thegovernmnet decided to tax consumers of gasonline instead? That is, what if everytime you purchased gasoline, it was your responsibility to send the governmnet acheck for $2 for every gallon you purchased? How would this change theequilibrium quantity and price in the gasoline market?
CHAPTER 11. GOVERNMENT INTERVENTIONS 88
First note that the price-intercept of the demand curve is at $8 implying thatconsumers will start to demand positive amounts of gasoline once the price is below$8. If consumers have to pay $2 to the governmnet for every gallon they purchase,then the total price paid for gasoline is the price they pay at the pump plus the $2tax. Therefore, since no consumer demands any gasonline unless the price is lessthan $8 total, the price at the pump must now be below $6.
Mathematically, we can represent the consumers’ demand with the tax by sub-tracting the $2 tax from their demand curve since they are willing to pay $2 lessper gallon at the pump. The demand curve with the tax is then
P = 8 − 2 − 1
5QD
P = 6 − 1
5QD.
Figure 11.6 displays the effect of taxing consumers. The equilibrium quantityis the same as before, 12.5 million gallons. However, the equilibrium price is now$3.50. When a tax on gasoline is introduced, demand decreases as each consumeris willing to purchase less for any given price because they now have an additionalcost of paying $2 to the government not included in the price. This creates a surplus(excess supply) of 10 million gallons putting downward pressure on price until thenew equilibrium is reached at $3.50.
S
DDT
7.5 12.5 17.5 30 40Q
1
3.54.5
6
8
P
Figure 11.6: Gasoline in CA
Regardless of who is taxed, equilibrium quantity falls when a tax is introduced.Here we can see another use for taxes, to discourage behavior. It is well knownthat the production and use of gasonline is harmful to the environment. One way agovernmnet can reduce the amount of gasonline people use is to tax its sale. Thisis the main argument behind so-called “sin taxes” on cigarettes and alcohol.
CHAPTER 11. GOVERNMENT INTERVENTIONS 89
ST
S
D
12.5 17.5 40Q
1
3.54.55.5
8
P
Figure 11.7: Binding Price Floor
11.3 Consumers’ and Producers’ Tax Burden
Author: Craig Kerr
In the previous section, we saw that the equilibrium price of gasoline did notchange by the full amount of the tax regardless of whether consumers or producerswere taxed. When producers were taxed $2 a gallon, the price increased by $1.When consumers were taxed, the price decreased by $1. In both cases, producersand consumers shared the burden of a tax.
Figure 11.7 represents the market for gasoline for when producers are taxed $2.Note that the supply curve shifts by the amount of the tax ($2) but the equilibriumprice only increase by half the amount (from $4.50 to $5.50). This new equilibriumprice is paid by consumers and is therefore called the buyer’s price. Every consumerthat is still purchasing gasoline is now paying $1 more than they otherwise wouldhave without the tax even though it is the producers who are being taxed. Thus,the consumer tax burden is $1.
With a $2 tax on producers of gasoline, the equilibrium market price is $5.50 butproducers only keep $3.50 after taxes are paid. This after-tax dollar amount is whatwe call the sellers’ price and it appears on the graph where the new equilibriumquantity meets supply curve without the tax. The seller’s price is $1 less than theywould receive if there were no taxes on gasoline. We therefore say that the producertax burden is also $1.
What are the prices paid by consumers and producers when the tax is insteadlevied on consumers? Does the tax burden shift toward consumers in this case? Fig-ure 11.8 displays the graph for when consumers are taxed $2 per gallon of gasoline.In this case, the new equilibrium price is $3.50. Since producers do not pay the tax,this is the seller’s price and it is the same as when they are taxed. Consumers pay$3.50 at the pump and an additional $2 in taxes to the government. The buyer’s
CHAPTER 11. GOVERNMENT INTERVENTIONS 90
S
DDT
12.5 17.5 40Q
1
3.54.55.5
8
P
Figure 11.8: Tax on Consumer
price is then $5.50, which is identical to when producers were taxed.Since the seller’s price and buyer’s price are unchanged copmared to when pro-
ducers are taxed, the tax burdens are also unchanged. This shows us an interestingfact of taxation: when it comes to tax burdens and the prices paid by consumersand received by producers, it does not matter which agent is taxed.
So then why is it that producers are the lucky ones chosen to pay the gasolinetax (and sales tax too for that matter)? Practically, it makes more sense to taxthe producers. They likely have much more to lose if they are found guilty of notpaying the tax and may have difficulty hiding the amount of gasoline they sold.In contrast, a consumer could easily pay cash for his gasonline so that there is norecord and not report the purchase to the IRS. Lastly, it is more efficient to have asingle gas station report its sales rather than the potential millions of consumers itservices ever year.
In the example above, the consumer and producer shared equally in the taxburden but this is not always the case. The amount each agent pays is dependenton the elasticity of their supply or demand curves. Observe what happens to thetax burden and prices paid by consumers and producers when demand for gasolinebecomes more inelastic. Figure 11.9 rotates demand around the initial equilibriumprice of $4.5 and equilibrium quanitty of 17.5 million barrels so that we can compareit to Figure 11.8.
With a more inelastic demand, the burden is shifted to the consumer who nowpays $5.72 and has a tax burden of $1.22. Producers now receive $3.72 and onlyhave a tax burden of $0.78. You may also notice that the new equilibrium quantitywith the tax is more than in Figure 11.8. This is because demand in Figure 11.9 ismore inelastic so when the price that buyers pay increase due to a tax, the decreasein their quantity demanded is relatively smaller. This is also why they have more ofthe burden; prices at the pump decrease with the decrease in demand. If demand
CHAPTER 11. GOVERNMENT INTERVENTIONS 91
S
DDT
13.6 17.5 31.8Q
1
3.724.5
5.72
10P
Figure 11.9: Tax on Consumer with Inelastic Demand
decreases less, the price will also decrease less. In general, the more elastic (inelastic)consumers or producers are, the less (more) of the tax burden they will bear.
CHAPTER 11. GOVERNMENT INTERVENTIONS 92
11.4 Welfare Effects of a Tax
Author: Craig Kerr
In previous sections, we saw how taxes decrease equilibrium quantity and drivea wedge between the price that consumers pay and the price that producers receive.As you might have guessed, this causes a loss of welfare in aggregate for bothgroups. Figure 11.10 displays the market for gasoline when a $2 tax is applied.
A
B
C
D
E
F
S
D
12.5 17.5 40Q
1
3.5
4.5
5.5
8
P
Figure 11.10: Gasoline in CA
Without a tax on gasoline, consumers have a surplus equal to the area below thedemand curve and above the price (Consumer Surplus = A+B+E). When a $2 taxis introduced, consumers will pay $5.50 in total per gallon and only purchase 12.5million gallons regardless of whether producers or consumers are taxed. Consumersurplus will then be equal to Area A.
Without a tax on gasoline, producers have a surplus equal to the area below theprice and above the supply curve (Producer Surplus = C + D + F ). When a $2tax is introduced, producers will receive $3.50 in total per gallon and only sell 12.5million gallons regardless of whether producers or consumers are taxed. Producersurplus will then be equal to Area D.
What happens to areas B, C, E, and F? The government collects $2 a gallonin tax revenue for each of the 12.5 million gallons sold or $25 million dollars. Thisdollar amount is the summation of areas B and C. Presumably, the governmnetuses these funds to provide services to their citizens, which in turn increases their
CHAPTER 11. GOVERNMENT INTERVENTIONS 93
Table 11.1: Welfare Changesw/o tax w/ tax Change
CS A+B+E A -(B+E)
PS C+D+F D -(D+F)
Tax Revenue None B+C B+C
TS A+B+C+D+E+F A+B+C+D -(E+F)
welfare. However, Areas E and F are no longer surpluses for consumers or producersnor are they claimed by the government.
The combination of areas E and F is called dead-weight loss or excess burdenand its magnitude represents the welfare lost in the gasoline market from the intro-duction of the tax. We can calculate the amount here by using the formula for thearea of a triangle (recall that quality is in millions of gallons).
Area =1
2× base×height
DWL =1
2× (17.5 − 12.5) × ($5.5 − $3.5)
= $5 million
The total amount of welfare lost in the market for gasoline when a $2 tax isintroduced is $5 million. Table 11.1 summarizes the welfare changes from applyinga tax to the sale of gasoline.
Some goods and services will have more dead-weight loss when taxed thanothers. The elasticity of supply and demand determine the amount of dead-weightloss created by a tax. To see this, note that the dead-weight loss in Figure 11.1 isproportional to the decline in equilibrium quantity. The more elastic consumers are,the more sensitive they are to an increase in price and the more they will decreasetheir quantity demanded when the good or service under question is taxed.
Figure 11.11 displays the areas of surplus, tax revenue, and dead-weight losswhen demand is more inelastic. When this is the case, consumers are less responsiveto the increase in price and dead-weight loss is less than when demand is relativelyelastic. When demand is more inelastic, the dead-weight loss is approximately equalto
DWL =1
2× (17.5 − 13.6) × ($5.72 − $3.72)
= $3.9 million
CHAPTER 11. GOVERNMENT INTERVENTIONS 94
S
D
E
D
B
C
A
F
13.6 17.5 31.8Q
1
3.72
5.72
10P
Figure 11.11: Gasoline in CA
If taxes create dead-weight loss, why have them at all? When would having atax be welfare maximizing? We have shown here how taxes create inneficiencies incompetitive markets but we did not address exactly what the government did withthe tax revenue collected. If the welfare generated with the tax revenue exceeds theloss it creates in the gasoline market, then taxing goods and services may actuallybe welfare increasing. In addition, the pollution caused by gasoline decreases thewelfare of all who inhale its fumes. We will discuss in future chapters why wemay require a government to restrict the consumption of gasoline. As discussedabove, taxing the consumption of gasoline is one way a government can decreasethe equilibrium quantity of gasoline.
11.4.1 Dead-Weight Loss and the Laffer Curve
The objective of any government arguably should be to maximize welfare. Wediscussed above how the use of tax revenue may increase welfare. But let us considerfor moment a government that simply seeks to maximize tax revenue. How muchshould it tax?
If the tax is set to zero, then the government collects no revenue. A smalltax may affect supply and/or demand but would bring in positive amounts of taxrevenue. Lastly, there is some tax sufficiently high enough for which no consumerwould buy the good or service being taxed. If the government taxed $10,000 agallon for gasoline, perhaps not even the most wealthy consumer would demandany. Thus, if tax revenue collected increases as the tax increases from zero initially
CHAPTER 11. GOVERNMENT INTERVENTIONS 95
but ends up back at zero for a sufficiently high tax, then the relationship betweentaxes and tax revenue may look something like Figure 11.12. This curve is knownas a Laffer Curve.
tax
tax revenue
Figure 11.12: Laffer Curve
The main lesson to be learned from observing Figure 11.12 is that even if thegovernment’s objective is to maximize tax revenue, higher taxes do not necessarilymean more tax revenue. The formula for tax revenue is
TR=t×Q(t)
where TR is tax revenue, t is the amount of the tax, and Q(t) is the equilibriumquantity, which is a decreasing function of t. At some point, the increase in thetax is offset by the decrease in quantity purchased and tax revenue will actuallyfall as taxes increase. This relationship should restrict the amount of taxation agovernmnet imposes.
Another reason to restric the use of taxes is the exponential effect they have ondead-weight loss. Note that the formula for dead-weight loss can be written as
DWL =1
2× t×∆Q
since the base of the triangle in Figure 11.10 is the amount of the tax and the heightis the change in quantity. From this equation, we observe that if the governmnetdoubles some tax, we would replace t with 2t. Note that if the amount of the taxincreases, then so does the change in quantity. Thus, a doubling of taxes will morethan double the deadweight loss. That is, dead-weight loss increases exponentiallywith the amount of a tax. The relationship is described in Figure 11.13.
CHAPTER 11. GOVERNMENT INTERVENTIONS 96
tax
DWL
Figure 11.13: DWL from tax
CHAPTER 11. GOVERNMENT INTERVENTIONS 97
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11.6 End of Chapter Questions
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Deriving Individual Demandfrom Preferences
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Deriving Firm Supply fromCost of Production
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13.1 Types of Cost
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13.2 Graphical Representation of Cost Types
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13.3 Optimal Production Quantity in a CompetitiveMarket
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13.4 Deriving the Short Run Supply Curve for aCompetitive Market
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13.5 Deriving the Long Run Supply Curve for aCompetitive Market
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13.7 End of Chapter Questions
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Monopoly
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14.1 Profit Maximizing
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14.1.1 Conditions for a Profit Maximum
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14.1.2 Deriving the Monopolist’s Profit Maximum in a MarketDiagram
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14.2 Welfare Effects
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14.3 Monopolistic Competition
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14.4 Price Discrimination
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14.5 Videos, Simulations, and other Internet Re-sources
Instructional Videos
Each video covers a selected concept of content.
For Section: 14 Monopoly
Introduction to Monopoly Marketsby Carsten Lange
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Monopoly Profit Maximizationby Carsten Lange
Gives a general overview of how monopolies maximize profit and how their profitchanges as their output changes.Click here to start ID:21 Click here to rate
Monopolistic Output Determination (Diagramatically)by Carsten Lange
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Calculating Monopoly Profitby Carsten Lange
Explains how to find the profit-maximizing level of output in a monopoly marketand how to calculate profit at this output level. Also explains the monopolist’smarginal revenue curve as it relates to profit determination.Click here to start ID:22 Click here to rate
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14.6 End of Chapter Questions
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Oligopoly
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15.1 Profit Maximization in a Duopoly
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15.2 A Game Theory Approach
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