Week 3 - Elasticity and Market Efficiency EC1101E, NUS, Spring 2020. - PowerPoint PPT Presentation

More realistic setting: animals can and do reproduce Price (per animal) In fact, as any other business, they will respond to prices Q (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Hunting agencies supply curve Price (per animal) Q (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Hunting agencies supply curve Price S (per animal) Q (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Market after hunting becomes legal Price S 0 S 1 (per animal) Old equilibrium before hunting is legalized $1,000 D 1 D 0 Q 100 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Market after hunting becomes legal Price S 0 S 1 (per animal) New equilibrium after hunting is legalized $1,600 $1,000 D 1 D 0 Q 100 130 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Market after hunting becomes legal Price S 0 S 1 (per animal) Note: if hunting agencies allowed to “farm” animals, then the stock of endangered species increases from $1,600 New 100 to 130. $1,000 D 1 Given agencies want to make profits Old in the long term, this is a sustainable equilibrium that guarantees animals D 0 in the long run Q 100 130 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Market after hunting becomes legal Price S 0 S 1 (per animal) Note: if hunting agencies allowed to “farm” animals, then the stock of endangered species increases from $1,600 New 100 to 130. $1,000 D 1 Given agencies want to make profits Old in the long term, this is a sustainable equilibrium that guarantees animals D 0 in the long run. Q 100 130 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

What if there is a demand shock? EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

What if there is a demand shock? • Paradoxically, the more people want to go hunting… • …the more animals will be present • (details of a demand shock: next slide ) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Market after hunting becomes legal Price S 0 S 1 (per animal) Suppose: Demand shock $2,200 NewER $1,600 Higher quantity of New D 2 animals in equilibrium $1,000 D 1 D 0 Q 160 100 130 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Market after hunting becomes legal • Suppose farming can respond faster to price changes • …then even more animals will be present EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Farming becomes more efficient/dynamic Price S 0 S 1 (per animal) $1,600 $1,000 D 1 D 0 Q 100 130 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Farming becomes more efficient/dynamic Price S 0 S 1 (per animal) " 1 𝑻 $1,600 $1,000 D 1 D 0 Q 100 130 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Farming becomes more efficient/dynamic Price S 0 S 1 (per animal) " 1 𝑻 $1,600 $1,200 New $1,000 D 1 D 0 Q 160 100 130 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Farming becomes more efficient/dynamic Price S 0 S 1 (per animal) " 1 𝑻 $1,600 More efficient/dynamic farming $1,200 New $1,000 D 1 Higher quantity of animals in equilibrium D 0 Q 160 100 130 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Protecting endangered species 1. Legalize hunting 2. Allow agencies to farm endangered species 3. Profit maximization will do the rest EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Protecting endangered species 1. Legalize hunting 2. Allow agencies to farm endangered species 3. Profit maximization will do the rest • RE-RE-RE policy: Ethically reprobable, reprehensible, revolting. • But it does work! Some advocate it as the best solution EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

What can we learn, more generally? EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

What can we learn, more generally? • Why does a more dynamic/efficient farming lead to higher number of animals? • Because agencies can respond faster to changes in prices • This refers to the elasticity EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Farming becomes more efficient/dynamic Price S 1 (per animal) More INELASTIC " 1 supply 𝑻 More ELASTIC supply Q (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Initially Price S 1 (per animal) " 1 𝑻 $1,600 • A price increase of $400 $1,200 • Quantity increases by 20 Q 110 130 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

As farming becomes more efficient/dynamic Price S 1 (per animal) " 1 𝑻 $1,600 $1,200 Q 210 150 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Farming becomes more efficient/dynamic Price S 1 (per animal) " 1 𝑻 $1,600 • A price increase of $400 $1,200 • Quantity increases by 60 Q 210 150 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Supply • The more elastic the supply, the better for the protection of endangered species • We want a precise measure: 𝑓 $ = %∆( ) %∆* • How responsive is quantity supplied to a price increase EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Supply • The more elastic the supply, the better for the protection of endangered species • We want a precise measure: 𝑓 $ = %∆( ) %∆* • How responsive is quantity supplied to a price increase EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

) ) %∆𝑅 $ = 100× ( /01 2( 345 6782668 • = 100× = 18.18% ) ( 345 668 EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

) ) %∆𝑅 $ = 100× ( /01 2( 345 6782668 • = 100× = 18.18% ) ( 345 668 * /01 2* 345 6<8826=88 • %∆𝑄 = 100× = 100× = 33.33 % * 345 6=88 EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

) ) %∆𝑅 $ = 100× ( /01 2( 345 6782668 • = 100× = 18.18% ) ( 345 668 * /01 2* 345 6<8826=88 • %∆𝑄 = 100× = 100× = 33.33 % * 345 6=88 %∆( ) 6@.6@ • 𝑓 $ = = 77.77 = 0.5454 %∆* EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

) ) %∆𝑅 $ = 100× ( /01 2( 345 6782668 • = 100× = 18.18% ) ( 345 668 * /01 2* 345 6<8826=88 • %∆𝑄 = 100× = 100× = 33.33 % * 345 6=88 %∆( ) 6@.6@ • 𝑓 $ = = 77.77 = 0.5454 %∆* • Every 1% increase in price results in a 0.54% increase in quantity supplied EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

) ) %∆𝑅 $ = 100× ( /01 2( 345 =6826C8 ) ) • = 100× = 40% %∆𝑅 $ = 100× ( /01 2( 345 6782668 • = 100× = 18.18% ) ( 345 6C8 ) ( 345 668 * /01 2* 345 6<8826=88 • %∆𝑄 = 100× = 100× = 33.33 % * /01 2* 345 6<8826=88 • %∆𝑄 = 100× = 100× = 33.33 % * 345 6=88 * 345 6=88 %∆( ) D8 %∆( ) • 𝑓 $ = = 77.77 = 1.20 6@.6@ • 𝑓 $ = = 77.77 = 0.5454 %∆* %∆* • Every 1% increase in price results in a 1.20% increase in • Every 1% increase in price results in a 0.54% increase in quantity supplied quantity supplied EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Supply • e s 0: Perfectly inelastic supply Large changes in prices barely change quantity supplied • • Vertical Supply curve • e s ∞: Perfectly elastic supply • Small changes in prices induce huge changes in quantity supplied • Horizontal Supply curve EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Supply • e s 0: Perfectly inelastic supply Large changes in prices barely change quantity supplied • • Vertical Supply curve • e s ∞: Perfectly elastic supply • Small changes in prices induce huge changes in quantity supplied • Horizontal Supply curve EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand • 𝑓 F = %∆( 5 %∆* • How responsive is quantity demanded to a price increase • Inelastic demand: not price sensitive • Elastic demand: very price sensitive EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand • 𝑓 F = %∆( 5 %∆* • How responsive is quantity demanded to a price increase • Which good has a very inelastic demand? • Which good has a very elastic demand? EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand • 𝑓 F = %∆( 5 %∆* • How responsive is quantity demanded to a price increase • Which good has a very inelastic demand? • Which good has a very elastic demand? EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand • 𝑓 F = %∆( 5 %∆* • How responsive is quantity demanded to a price increase • Which good has a very inelastic demand? Insulin • Which good has a very elastic demand? Mee Goreng EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand • Which good has a very inelastic demand? Insulin • People with diabetes *really* need it • They will pay whichever price for the daily quantity prescribed • Which good has a very elastic demand? Mee Goreng EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand • Which good has a very inelastic demand? Insulin • People with diabetes *really* need it • They will pay whichever price for the daily quantity prescribed • Which good has a very elastic demand? Mee Goreng • Has many close substitutes: Mee Rebus, Hokkien Mee, etc. • If price increases “too much”, consumers switch to other mee types EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand - graphically EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand - graphically Price D $200 $100 Q 900 920 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand - graphically Price D $200 • Price doubles • Quantity demanded $100 barely changes Q 900 920 EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand - graphically Price D $200 • We want to be more precise $100 Q 900 920 EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand - graphically Price D $200 5 5 %∆𝑅 F = 100× ( /01 2( 345 G882G=8 = 100× = −2.17% • 5 G=8 ( 345 * /01 2* 345 =882688 %∆𝑄 = 100× = 100× = 100 % • * 345 688 %∆( 5 $100 2=.6J 𝑓 F = = = 0.0217 • %∆* 688 • Every 1% increase in price results in a 0.02% decrease in quantity demanded Q 900 920 (# animals) EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand - graphically Price D $200 5 5 %∆𝑅 F = 100× ( /01 2( 345 G882G=8 = 100× = −2.17% • 5 G=8 ( 345 * /01 2* 345 =882688 %∆𝑄 = 100× = 100× = 100 % • * 345 688 %∆( 5 $100 2=.6J 𝑓 F = = = 0.0217 • %∆* 688 • Every 1% increase in price results in a 0.02% decrease in quantity demanded Q 900 920 EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand - graphically Price D $200 5 5 %∆𝑅 F = 100× ( /01 2( 345 G882G=8 = 100× = −2.17% • 5 G=8 ( 345 * /01 2* 345 =882688 %∆𝑄 = 100× = 100× = 100 % • * 345 688 %∆( 5 $100 2=.6J 𝑓 F = = = 0.0217 • %∆* 688 • Every 1% increase in price results in a 0.02% decrease in quantity demanded Q 900 920 EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of Demand - graphically Price D $200 5 5 %∆𝑅 F = 100× ( /01 2( 345 G882G=8 = 100× = −2.17% • 5 G=8 ( 345 * /01 2* 345 =882688 %∆𝑄 = 100× = 100× = 100 % • * 345 688 %∆( 5 $100 2=.6J 𝑓 F = = = 0.0217 • %∆* 688 • Every 1% increase in price results in a 0.02% decrease in quantity demanded Q 900 920 EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

When demand is very inelastic… Price S D Q EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

When demand is very inelastic… Price S D • Q* virtually determined by demand only • P* virtually determined by supply only Q EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

When demand is very inelastic… Price S 1 S 0 D Q EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

When demand is very inelastic… Price S 1 S 0 D • Supply shift affects price p* • Barely affects quantity demanded in eq. Q EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity - summary EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of demand - summary • 𝑓 F = ∞ Perfectly elastic demand • 𝑓 F > 1 Elastic demand • 𝑓 F = 1 Unit-Elastic demand 𝑓 F < 1 Inelastic demand • • 𝑓 F = 0 Perfectly inelastic demand EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity of supply - summary • 𝑓 $ = ∞ Perfectly elastic supply • 𝑓 $ > 1 Elastic supply • 𝑓 $ = 1 Unit-Elastic supply 𝑓 $ < 1 Inelastic supply • • 𝑓 $ = 0 Perfectly inelastic supply EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity - comments • Direction matters! • Why is it useful? • If there are taxes or shifts, we know who is affected. • It also allows us to anticipate consequences of policies EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity – comments (1) p 8 7 2 1 Q 1 2 7 8 EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau

Elasticity – comments (1) p 8 7 2 1 Q 1 2 7 8 EC1101E, NUS, Spring 2020. Week 3. Guillem Riambau