ECONOMICS 11 MIDTERMS REVIEWER

2ND SEMESTER
Sir Chester Arcilla
Notes by me 😀
 SUPPLY, DEMAND, AND GOVERNMENT POLICIES the buyer who values it most) and often unfair.
HOW MARKETS WORK
Control on Prices: How Price Ceilings Affect Market
Outcomes

● Price ceiling - a legal maximum on the price at

which a good can be sold (protects consumers)
● Price floor - a legal minimum on the price at which
a good can be sold (protect sellers) ● Rent control (price ceiling) in the short run and in
● Binding constraint - equilibrium price of $3 is above the long run
o Panel (a) shows the short-run effects of
the price ceiling
rent control: Because the supply and
demand curves for apartments are
relatively inelastic, the price ceiling
imposed by a rent-control law causes only
a small shortage of housing.
o Panel (b) shows the long-run effects of rent
control: Because the supply and demand
curves for apartments are more elastic, rent
control causes a larger shortage.

● Results of shortage -
o long lines: Buyers who are willing to arrive
early and wait in line get a cone, while
those unwilling to wait to do not.
o According to their own personal biases,
selling them only to friends, relatives, or
members of their own racial or ethnic
group.
● Price ceiling was motivated by a desire to help
buyers of ice cream, not all buyers benefit from the ● Supply and demand are inelastic in the short run,
policy the initial shortage caused by rent control is small.
● Buyers pay a lower price, and although they may ● long-run story is very different because the buyers
have to wait in line to do so, other buyers cannot and sellers of rental housing respond more to
get any ice cream at all. market conditions as time passes
● When the government imposes a binding price ● supply side, landlords respond to low rents by not
ceiling on a competitive market, a shortage of the building new apartments and by failing to maintain
good arises, and sellers must ration the scarce existing ones.
goods among a large number of the potential buyer
● demand side, low rents encourage people to find
● Long lines are inefficient because they waste
their own apartments (rather than living with
buyers’ time. Discrimination according to seller bias roommates or their parents) and induce more
is both inefficient (because the good may not go to people to move into the city.
● When rent control depresses rents below the
equilibrium level, the quantity of apartments
supplied falls substantially and the quantity of
apartments demanded rises substantially. The
result is a large shortage of housing.
 ● Rent control creates shortages and waiting lists,
landlords lose their incentive to respond to tenants’
concerns. Why should a landlord spend money to
maintain and improve the property when people are
waiting to move in as it is? In the end, tenants get
lower rents, but they also get lower-quality housing.
● Without rent control, such laws are less necessary
because the market for housing is regulated by the
forces of competition.
● In a free market, the price of housing adjusts to ● Because the minimum wage is a price floor, it
eliminate the shortages that give rise to undesirable causes a surplus: the quantity of labor supplied
landlord behavior exceeds the quantity demanded. the result is
Control on Prices: How Price Floors Affect Market unemployment.
Outcomes

● attempt by the government to maintain prices at

other than equilibrium levels.
● equilibrium price is above the floor, the price floor is
not binding.
● Market forces move the economy to equilibrium,
and the price floor has no effect.
● below the floor, the price floor is a binding
● When policymakers set prices by legal decree, they
constraint on the market.
obscure the signals that normally guide the
● supply and demand tend to move the price toward allocation of society’s resources.
the equilibrium price, but when the market price hits ● Yet when policymakers impose price controls, they
the floor, it can fall no further
can hurt some people they are trying to help
● Sellers who appeal to the personal biases of the
● Rent control keeps rents low, but it also
buyers, perhaps due to racial or familial ties, may
be better able to sell their goods than those who do discourages landlords from maintaining their
not. buildings and makes housing hard to find.

● in a free market, the price serves as the rationing ● Minimum- wage laws raise the incomes of some
mechanism, and sellers can sell all they want at the workers, but they also cause other workers to
equilibrium price. become unemployed.
● Although these alternative policies are often better
than price controls, they are not perfect. Rent and
wage subsidies cost the government money and,
therefore, require higher taxes.

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

HOW MARKETS WORK II
Elasticity of Demand

● measures how much the quantity demanded

responds to a change in price.
 ● elastic if the quantity demanded responds ● Demand is considered inelastic when the elasticity
substantially to changes in the price. is less than one, which means the quantity moves
proportionately less than the price.
● Demand is said to be inelastic if the quantity
demanded responds only slightly to changes in ● If the elasticity is exactly one, the percentage
the price. change in quantity equals the percentage change in
price, and demand is said to have unit elasticity.
● measures how willing consumers are to buy less
of the good as its price rises. ● To understand the meaning and consequences of
What influences the price elasticity of demand? modernity, postmodernity and the new
globalization.
● Availability of Close Substitutes - A good
with close substitutes tends to have more
elastic demand because it is easier for
consumers to switch from that good to
others.
● Necessities versus Luxuries - Necessities
tend to have inelastic demands, whereas
luxuries have elastic demands.
● Definition of the Market - elasticity of
demand in any market depends on how we
draw the boundaries of the market. Ice
cream, a narrow category, has a more
elastic demand because it is easy to
substitute other desserts for ice cream.
● Time Horizon - more elastic demand over
longer time horizons.
Computing the Price Elasticity of Demand

Total Revenue and the Price Elasticity of Demand

Midpoint Method: A Better Way to Calculate

Percentage Changes and Elasticities
● total revenue - the amount paid by buyers and
received by sellers of a good.
● The elasticity from point A to point B seems ● P X Q, the price of the good times the quantity of
different from the elasticity from point B to point A. the good sold

● Demand is considered elastic when the elasticity is

greater than one, which means the quantity moves
proportionately more than the price.
● The impact of a price change on total revenue (the Other Demand Elasticities

product of price and quantity) depends on the

elasticity of demand. in panel (a), the demand curve ● Income elasticity of demand - a measure of how
is inelastic. much the quantity demanded of a good
responds to a change in consumers’ income,
computed as the percentage change in quantity
demanded divided by the percentage change in
income
● Cross-price elasticity of demand - a measure of
how much the quantity demanded of one good
responds to a change in the price of another
good, computed as the percentage change in
quantity demanded of the first good divided by
the percentage change in price of the second
good.

● demand is inelastic (a price elasticity less than

one), price and total revenue move in the same
The Elasticity of Supply
direction: If the price increases, total revenue
also increases.
● When demand is elastic (a price elasticity ● measures how much the quantity supplied
greater than one), price and total revenue move responds to changes in the price.
in opposite directions: If the price increases, total
revenue decreases. ● Elastic if the quantity supplied responds
● If demand is unit elastic (a price elasticity exactly
substantially to changes in the price.
equal to one), total revenue remains constant
when the price changes. ● Inelastic if the quantity supplied responds only
slightly to changes in the price.
Elasticity along a Linear Curve
● The price elasticity of supply depends on the
flexibility of sellers to change the amount of the
good they produce
● For example, beachfront land has an inelastic
supply because it is almost impossible to
produce more of it. (availability)
● Manufactured goods, such as books, cars, and
televisions, have elastic supplies because firms
 that produce them can run their factories longer
in response to higher prices.
● A key determinant of the price elasticity of
supply is the time period being considered.
● Supply is usually more elastic in the long run
than in the short run.
● Firms cannot easily change the size of their
factories to make more or less a good
● Short run, the quantity supplied is not very
responsive to changes in the price.
● Over longer periods of time, firms can build new
factories or close old ones.

● The Variety of Supply Curves

o Because the price elasticity of supply
measures the responsiveness of
quantity supplied to changes in price, it
is reflected in the appearance of the Three Applications of Supply, Demand and Elasticity
supply curve.

SUPPLY, DEMAND, AND GOVERNMENT POLICIES

HOW MARKETS WORK I
Markets and Competition
● Quantity demanded of any good is the
amount of the good that buyers are willing
and able to purchase
● Market - a group of buyers and sellers of a
particular good or service. ● Law of demand: Other things being equal,
when the price of a good rise, the quantity
● The buyers as a group determine the
demanded of the good falls, and when the
demand for the product, and the sellers as a price falls, the quantity demanded rises.
group determine the supply of the product.
● Demand schedule, a table that shows the
● Some markets are highly organized, such as
relationship between the price of a good and
the markets for agricultural commodities like the quantity demanded,
wheat and corn.
● Demand curve. The demand curve slopes
● In these markets, buyers and sellers meet at
downward because, other things being
a specific time and place. equal, a lower price means a greater
quantity demanded.
● Buyers come knowing how much they are Shifts in the Demand Curve
willing to buy at various prices, and sellers
come knowing how much they are willing to ● Any change that raises the quantity that buyers
sell at various prices.
wish to purchase at any given price shifts the
● An auctioneer facilitates the process by demand curve to the right. Any change that
keeping order, arranging sales, and (most lowers the quantity that buyers wish to purchase
importantly) finding the price that brings the at any given price shifts the demand curve to the
actions of buyers and sellers into balance. left.

● More often, markets are less organized. ● Demand curve to the right and is called an
(opposite) increase in demand.

● Competitive market - a market in which ● Any change that reduces the quantity demanded
there are so many buyers and so many at every price shifts the demand curve to the left
sellers that each has a negligible impact on and is called a decrease in demand.
the market price. ● Changes in many variables can shift the demand
● Perfectly competitive market curve
o The goods offered for sale are all ● Normal good - a good for which, other things
exactly the same,
o the buyers and sellers are so being equal, an increase in income leads to an
numerous that no single buyer or increase in demand
seller has any influence over the ● Inferior good - a good for which, other things
market price.
being equal, an increase in income leads to a
● Monopoly - Some markets have only one decrease in demand
seller, and this seller sets the price. ● Prices of Related Goods
● Perfectly competitive markets are the o When a fall in the price of one good
easiest to analyze because everyone reduces the demand for another good,
participating in them takes the price as given the two goods are called substitutes.
by market conditions. o When a fall in the price of one good
raises the demand for another good, the
two goods are called complements.
Demand ● Tastes
o The most obvious determinant of your
demand for any good or service is your
tastes.
 ● Expectations ● Equilibrium quantity - the quantity supplied
o Expectations about the future may affect and the quantity demanded at the equilibrium
your demand for a good or service price
today.
● Surplus - a situation in which quantity supplied is
● Number of Buyers greater than quantity demanded
o Market demand depends on the number
of these buyers. ● Shortage - a situation in which quantity
Supply demanded is greater than quantity supplied
● Quantity supplied of any good or service is the
amount that sellers are willing and able to sell
● Law of supply: Other things being equal, when
the price of good rises, the quantity supplied of
the good also rises, and when the price falls, the
quantity supplied falls as well.
● Supply schedule, a table that shows the
relationship between the price of a good and the
quantity supplied, holding constant everything
else that influences how much of the good
producers want to sell.
● Supply curve. The supply curve slopes upward
because, other things being equal, a higher price
means a greater quantity supplied.

Shifts in the supply curve

● Because the market supply curve is drawn

holding other things constant, when one of these
factors changes, the supply curve shifts.
● Input Prices
○ the supply of a good is negatively
related to the prices of the inputs used
to make the good.
● Technology
○ By reducing firms’ costs, the advance in
technology raised the supply of ice
cream.
● Expectations
○ If a firm expects the price of ice cream to
rise in the future, it will put some of its
current production into storage and sup-
ply less to the market today.
● Number of Sellers
○ If Ben or Jerry were to retire from the
ice-cream business, the supply in the
market would fall.

Supply and Demand Together

● Equilibrium - a situation in which the market

price has reached the level at which quantity
supplied equals quantity demanded
● Equilibrium price - the price that balances
quantity supplied and quantity demanded
 ● Whenever an event shifts the supply curve, the
demand curve, or perhaps both curves, you can
use these tools to predict how the event will alter

the price and quantity sold in equilibrium

MARKETS AND GOVERNMENT POLICY II

TAXES
How Taxes on Sellers Affect Market Outcomes
● Tax Incidence - the manner in which the burden
of a tax is shared among participants in a market
● Scenario: Local government passes a law
requiring sellers of ice-cream cones to send
$0.50 to the government for every cone they
sell.
● Three steps in Chapter 4 for analyzing supply
and demand:
○ (1) We decide whether the law affects
the supply curve or the demand curve.
○ (2) We decide which way the curve
shifts.
○ (3) We examine how the shift affects the
equilibrium price and quantity.
● 1st Step: The immediate impact of the tax is on
the sellers of ice cream.
● Because the tax is not levied on buyers, the
quantity of ice cream demanded at any given
price remains the same; thus, the demand curve
does not change.
● The tax on sellers makes the ice-cream
business less profitable at any given price, so it
shifts the supply curve.
● 2nd Step: Because the tax on sellers raises the
cost of producing and selling ice cream, it
reduces the quantity supplied at every price.
● The supply curve shifts to the left (or,
equivalently, upward).
● 3rd Step: The equilibrium price of ice cream
rises from $3.00 to $3.30, and the equilibrium
quantity falls from 100 to 90 cones.
● Because sellers sell less and buyers buy less in
the new equilibrium, the tax reduces the size of
the ice-cream market.
● Taxes discourage market activity. When a good
is taxed, the quantity of the good sold is smaller
in the new equilibrium.
● Buyers and sellers share the burden of taxes. In
the new equilibrium, buyers pay more for the
good, and sellers receive less.
 not fall by much, so sellers bear only a small
How Taxes on Sellers Affect Market Outcomes

● Scenario: Suppose that our local government

passes a law requiring buyers of ice-cream
cones to send $0.50 to the government for each
ice-cream cone they buy.
● 1st step: The immediate impact of the tax is on
the demand for ice cream.
● The supply curve is not affected because, for
any given price of ice cream, sellers have the
same incentive to provide ice cream to the
market.
● Buyers now have to pay a tax to the government
(as well as the price to the sellers) whenever
they buy ice cream.
● 2nd step: Because the tax on buyers makes
buying ice cream less attractive, buyers demand
a smaller quantity of ice cream at every price.
● 3rd step: the equilibrium price of ice cream falls
from $3.00 to $2.80, and the equilibrium quantity
falls from 100 to 90 cones. The tax on ice cream
reduces the size of the ice-cream market. And
once again, buyers and sellers share the burden
burden.
of the tax.
● By contrast, the price paid by buyers rises sub-
● Sellers get a lower price for their product; buyers
stantially, indicating that buyers bear most of the
pay a lower market price to sellers than they
burden of the tax.
previously did, but the effective price (including
● Panel (b) of Figure 9 shows a tax in a market
the tax buyers have to pay) rises from $3.00 to
with relatively inelastic supply and very elastic
$3.30.
demand. In this case, sellers are not very
● The tax places a wedge between the price that
responsive to changes in the price (so the
buyers pay and the price that sellers receive.
supply curve is steeper), whereas buyers are
The wedge between the buyers’ price and the
very responsive (so the demand curve is flatter).
sellers’ price is the same whether the tax is
● The figure shows that when a tax is imposed,
levied on buyers or sellers.
the price paid by buyers does not rise by much,
● In either case, the wedge shifts the relative
but the price received by sellers falls
position of the supply and demand curves. In the
substantially. Thus, sellers bear most of the
new equilibrium, buyers and sellers share the
burden of the tax.
burden of the tax.
● The two panels of Figure 9 show a general
● The only difference between a tax levied on
lesson about how the burden of a tax is divided:
sellers and a tax levied on buyers is who sends
A tax burden falls more heavily on the side of
the money to the government.
the market that is less elastic. Why is this true?
● In essence, the elasticity measures the
Elasticity and Tax Incidence willingness of buyers or sellers to leave the
market when conditions become unfavorable.
● When a tax is imposed on a market with these
elasticities, the price received by sellers does
● A small elastic- ity of demand means that
buyers do not have good alternatives to
consuming this particular good.
● A small elasticity of supply means that sellers do
not have good alternatives to producing this
particular good.
● When the good is taxed, the side of the market
with fewer good alternatives is less willing to
leave the market and, therefore, bears more of
the burden of the tax.