Microeconomics: Market Shocks & Producer/Consumer Surplus

Transcription

1 HO 2207 (Economics) Learning Centre Microeconomics: Market hocks & roducer/consumer urplus hocks to supply and demand in a market equilibrium situation were discussed in the upply & emand worksheet. In those cases, we only looked at ONE disturbance at a time. It is possible for both the demand and supply curves to shift at the same time. Use the matrix below to help you determine the total impact of two changes at once: Curve Change Effect on e Effect on e emand e e emand e e upply e e upply e e If two events result in an increase in supply and a decrease in demand, what is the effect on equilibrium price and quantity? Take the two relevant rows of the matrix and add the effects: ince both the shift in supply and in demand result in a decrease in equilibrium price, the total effect of both curves shifting is a decrease in e. However, the effect on equilibrium quantity from the two shifts is opposite (in one case quantity increases and in the other case quantity decreases), so we cannot know the overall change in equilibrium quantity. It could be an increase or a decrease depending on the magnitude of each curve s shift. upply e e emand e e Total effect: e e? When a market is in a period of disequilibrium (either a surplus or a shortage), the market is functioning at a price where supply is NOT equal to demand. The price is higher or lower than the equilibrium price and there will be pressure from market forces to return to the equilibrium price. e d e s urplus: > e, quantity supplied ( s ) > quantity demanded ( d ) hortage: < e, quantity supplied ( s ) < quantity demanded ( d ) e s e d tudent review only. May not be reproduced for classes. Authored by Emily impson

2 CONUMER AN ROUCER URLU Recall that marginal benefit is the additional benefit or happiness obtained with each additional unit of good consumed (or purchased). A consumer will continue to consume up to the point where marginal benefit equals the market price of the good. The demand curve is basically a marginal benefit curve for the entire market that shows monetarily how each additional unit of good is valued at bringing satisfaction. Consumer surplus is the monetary difference between the price consumers are willing to pay for a given quantity of a good (marginal benefit), and the price they actually pay for the good (market price). For example, if a soda costs $0.75, but a consumer is willing to pay for the first soda is $1.25, the consumer surplus is $0.50. ince a consumer s marginal benefit decreases with each additional unit of good, the consumer surplus will also decrease with each additional unit of good consumed. (This is why sales are so TC effective: while a consumer will pay full price for the first unit of good, the second unit of good is more likely to be purchased if offered at reduced price buy one, get one 50% off! ) e Total consumer surplus (TC) is found by summing up the consumer surplus for each quantity of good for all buyers. On a graph, it is represented by the area below the demand curve and above the equilibrium price (diagonal lines). T e Recall that marginal cost is the additional cost of producing an additional unit of a good. The supply curve is the marginal cost curve for the entire market; it shows how much each additional unit of good costs suppliers to produce. roducer surplus is the difference between the price suppliers receive for the good (market price) and the cost of making the good. The total producer surplus (T) is found by summing up the producer surplus for each quantity of good for all sellers. On a graph, it is represented by the area below the equilibrium price and above the supply curve (checker squares). RICE ELATICITY OF EMAN (ε ) rice elasticity tells us how sensitive the quantity demanded of a good is to a change in the price of a good on the market. The general formula is below, where subscript 2 are values after the price change, and subscript 1 are values before the price change: ε = ercentage change in quantity ercentage change in price = 2 1 ( )/2 2 1 ( )/2 tudent review only. May not be reproduced for classes. 2

3 rice and quantity demanded are negatively correlated (as one moves up the other moves down), so elasticity of demand will always be negative. However, the norm is to take the absolute value of the elasticity of demand (make it positive) and then comment on the elasticity of the good based on where it falls in the three ranges below: (1) When ε > 1, it is called an elastic good. The percent change in quantity is greater than the percent change in price, meaning people alter their buying patterns a lot in response to a small difference in price (very sensitive to price). (2) When ε = 1, it is called a unit elastic good. The percentage change in quantity demanded (or supplied) is the same as the percentage change in price. (3) When ε < 1 for a good, it is called an inelastic good. A change in price will not have much effect on the quantity demanded (or supplied). There are also two special cases: perfectly inelastic and perfectly elastic goods. For a perfectly inelastic good ε = 0, and the quantity demanded will remain exactly the same regardless of price. This is the graph on the left below, with a vertical demand curve (think of drawing the i ). For a perfectly elastic good ε =, so at a set price the quantity demanded is infinite. This appears in the graph on the right below as a horizontal demand curve (think about drawing the three horizontal lines in an E). $5 40 eterminants of Elasticity of emand 1. ubstitutability (lots of substitutes = more elastic) 2. Luxury vs necessity item (luxury items = elastic; necessities = inelastic) 3. ercentage of household budget (the larger the percentage, the more elastic; the smaller the percentage the more inelastic) 4. Length of time since price change (the more time that has passed the more elastic demand is; in the short run it is harder to change consumption habits/find substitutes = more inelastic) tudent review only. May not be reproduced for classes. 3

4 ractice roblems 1. True or false: If the demand equation is = 14 2, the supply equation is = 3 s, and the price is set equal to $6, there will be a surplus and prices will fall. Explain your reasoning and draw a graph. 2. True or false: If the demand curve shifts left and the supply curve shifts left, the equilibrium price will rise. Explain your reasoning. 3. Tea and scones are complementary goods. A decrease in the price of tea, coupled with an increase in the number of bakeries selling scones will increase/decrease/unknown the equilibrium price of scones and increase/decrease/unknown the equilibrium quantity of scones. 4. Felix loves cupcakes. The maximum he is willing to pay for his first cupcake is $3.75 and his maximum willingness to pay decreases by $0.50 after each cupcake he consumes. If the market price of a cupcake is $2.50, calculate Felix s total consumer surplus and the number of cupcakes he will consume. 5. A higher market price due to a decrease in supply will increase/decrease consumer surplus. 6. Which of the following is true about producer surplus? a. roducer surplus is shown graphically as the area above the supply curve and below the market price. b. roducer surplus is the difference between the price sellers are paid and the cost of producing those units c. A decrease in market price due to a decrease in demand will increase producer surplus. d. a and b are true e. a, b, and c are true 7. etermine the elasticity of demand for white paper when the price increases from 30 to 40 and the quantity demanded changes from 85 to 80 boxes. Is this an elastic good? 8. The price elasticity of demand of the product you are selling is 0.6 and you wish to increase your sales levels by 30%. You could accomplish that result by decreasing your price by %? 9. True or false: If the demand for a good is unit elastic, an 8% increase in price will cause an 8% increase in quantity demanded. Explain. tudent review only. May not be reproduced for classes. 4

5 olutions 1. F. At a price of $6, the = 4 units and = 2 units. ince d > s, this is a shortage. There will be pressure for prices to rise to return to equilibrium price. Graph is shown to the right. 2. F. Change in equilibrium price is unknown, equilibrium quantity will decrease. (, e +, e = e?) 3. unknown, increase e $ TC = $2.25 ($ $ $0.25); Felix will consume 3 cupcakes. Cupcakes rice Willingness to ay Consumer urplus 1 $2.50 $3.75 $ $2.50 $3.25 $ $2.50 $2.75 $ $2.50 $2.25 -$ decrease 6. d 7. ε = 0.21; No, since ε < 1 this is an inelastic good % 9. F. rice and quantity demanded are negatively correlated. An 8% increase in price will result in an 8% decrease in quantity demanded. tudent review only. May not be reproduced for classes. 5