Elasticity

1. Elasticity adding (quantitative) meat to the bones of supply and demand

2. Suppose the price of gas rises by 10% over the next month. By how much will Ohio drivers cut back on their purchases of gasoline? • 0 percent (no cut back) • 1 to 5 percent • 6 to 10 percent • 11 to 20 percent • More than 20 percent

3. %ΔP %ΔQ Price Elasticity of Demand • Measures the price sensitivity of buyers Ed = $ $2.50 $2.00 D Gasoline 280 300

4. %ΔP Degree of Sensitivity Elastic: |Ed| > 1 Unit: |Ed| = 1 Inelastic: |Ed| < 1 %ΔQ Midpoint Formula Ed = = Ed = -[.07/.22] = -0.32 $ $2.50 $2.00 D Gasoline 280 300

5. When the price of an iPod Nano is $130, consumers buy 500 units per week. When the price rises to $150, consumers buy only 400 units per week. What is the midpoint elasticity of demand and how would you classify it? • -1.57; inelastic • -1.57; elastic • -0.64; inelastic • -0.64; elastic Ed = Ed = -.22/.14 = -1.57

6. Determinants of Elasticity • Number of substitutes • The greater the # substitutes, the greater the elasticity • The narrower the definition of the market, the greater the elasticity • Ex: • Item’s share of consumer budget • The greater the share of budget, the greater the elasticity • Ex: Ehousing > Esalt Ecars < Echevys < Ecamaros < Ebitch’n camaros

7. Determinants of Elasticity • Time: Short Run v. Long Run • The longer the time horizon, the greater the elasticity $ Gasoline Demand: ELR > ESR P1 P0 D1 long run D2 short run gasoline Q1 Q2 Q0

8. Extreme Cases of Price Elasticity $ D1 • Perfectly Inelastic • Ed = • Examples? • Perfectly Elastic • Ed = • Examples? P2 0 P1 Q Q1 $ ∞ D1 P1 Q

9. Some Estimated Price Elasticities of Demand • GoodPrice elasticity • Inelastic demand • Eggs - 0.10 • Beef - 0.40 • Stationery - 0.50 • Gasoline - 0.50 • Elastic demand • Housing - 1.20 • Restaurant meals - 2.30 • Airline travel - 2.40 • Foreign travel - 4.10

10. Elastic Demand P x Q = TR P x Q = TR Inelastic Demand P x Q = TR P x Q = TR Ed = Elasticity and Total Revenue TR = P x Q Quantity effect dominates Price effect dominates

11. Suppose that the price elasticity of demand for a Marietta College education is estimated to be E = -0.80. Based on this information, if the college were to raise tuition by 5%, then: • enrollment will fall by 6.25% and tuition revenues will increase. • enrollment will fall by 4% and tuition revenues will increase. • enrollment will fall by 6.25% and tuition revenues will decrease. • enrollment will fall by 4% and tuition revenues will decrease.

12. According to recent studies at M.I.T. and the University of Michigan, a 10% increase in the price of cigarettes leads to a 14% drop in sales to teenagers. What is the elasticity of demand for cigarettes among teenagers? • -0.71 • -1.40 • +1.40 • +0.71 Would you expect it to be this high for older smokers? Explain.

13. Cigarette Tax Revisited S2 (with tax) Assume that ED = -0.60 price S1 ED = = -0.60 4.40 %ΔP = 10% 4.00 t = $1 %ΔQD = - 6.0% 3.40 D1 What happens to total consumer expenditures? cigarettes 27.4 25.8 %ΔQD = - 6% What happens to tax revenue if demand becomes more elastic?

14. Other Demand Elasticities • Cross-Price Elasticity • Exy = • Income Elasticity • EI = Substitutes: Exy > 0 Complements: Exy < 0 Normal Goods: EI > 0 Inferior Goods: EI < 0

15. Examples of cross-price elasticities

16. Examples of income elasticities

17. It’s registration time…how about economics? Major Econ 211 (Micro I) Econ 212 (Macro I) Econ 349 (Micro II) Econ 375 (Macro II) Math 123 (Stats) Econ 420 (Applied Regression) Econ 421 (Empirical Research) 12 additional hours in Econ 33-34 hours Minor Econ 211 Econ 212 Math 123 9 additional hours in Econ 18 hours Spring 2010 • Econ 212 (Macro I) • Econ 301 (Money & Banking) • Econ 325 (Gender Econ) • Econ 330 (Health Econ) • Econ 350 (Enviro Econ) • Econ 420 (Applied Regression) • Econ 421 (Empirical Research) Fall 2010 (tentative) • Econ 212 (Macro I) • Econ 340 (Sports Economics) • Econ 349 (Micro II) • Econ 414 (Int’l Trade) • Econ 421 (Empirical Research)

18. Taxes Who bears the burden of a tax? Fairness vs. Efficiency Structure of the US Tax System

19. Economic Impact of Excise Taxes The “tax wedge” $ S1 tax wedge P1 D1 Q1 Beer Pbuyer DWL Tax Revenue Pseller Q2

20. Tax incidence depends on the elasticities of demand and supply 1990 Luxury tax on yachts was expected to generate $31 million in tax revenues; it only generated $16.6 million Economic Impact of Excise Taxes $ S1 D1 Q1 Yachts Pbuyer Tax Revenue P1 Pseller Q2

21. Tax Fairness and Tax Efficiency What makes a “fair” tax? Benefits Principle Ability to Pay Principle Trade-off between fairness and efficiency Lump sum taxes?

22. US Tax System

23. US Tax System

24. US Tax System

25. US Tax System Tax Base Income tax Payroll tax Sales tax Profits tax Property tax Wealth tax Tax Structure Proportional tax Progressive tax Regressive tax Problem Set 3: #11

26. US Tax System

27. US Tax System Top marginal tax rate 100% 80 60 40 20 1913 1920 1940 1960 1980 2000 2007 Year

28. A federal tax of $500 for each new car purchased that finances highway safety programs. Performs well according to both the benefits principle and the ability-to-pay principle. Performs well according to the benefits principle, but not the ability-to-pay principle. Performs well according to the ability-to-pay principle but not the benefits principle. Does not perform well according to either the benefits or ability-to-pay principle.

29. A local tax of 20% on hotel rooms that finances local government expenditures Performs well according to both the benefits principle and the ability-to-pay principle. Performs well according to the benefits principle, but not the ability-to-pay principle. Performs well according to the ability-to-pay principle but not the benefits principle. Does not perform well according to either the benefits or ability-to-pay principle.

30. A local tax of 1% of the assessed value of homes that finances local schools. Performs well according to both the benefits principle and the ability-to-pay principle. Performs well according to the benefits principle, but not the ability-to-pay principle. Performs well according to the ability-to-pay principle but not the benefits principle. Does not perform well according to either the benefits or ability-to-pay principle.

31. A 1% sales tax on food that pays for government food safety regulation and inspection programs. Performs well according to both the benefits principle and the ability-to-pay principle. Performs well according to the benefits principle, but not the ability-to-pay principle. Performs well according to the ability-to-pay principle but not the benefits principle. Does not perform well according to either the benefits or ability-to-pay principle.

32. International Trade Who gains and who loses from int’l trade? What is the impact of protectionism?

33. The Growing Importance of Int’l Trade

34. America’s Top Exports (2008)

35. America’s Top Imports (2008)

36. Ricardian Model Comparative Advantage Revisited Assumes constant opportunity cost Countries will specialize production in those goods in which it is the lowest opp. cost producer Trade makes both countries better off compared to autarky Comparative Advantage Handout

37. Economic Roundtable: November 18Marietta Country Club Dr. Pietra Rivoli Georgetown University

38. Sources of Comparative Advantage International differences in climate Chilean grapes (in the winter) Vietnamese shrimp Brazilian sugar cane Differences in technology Japanese autos Swiss watches Factor endowments Canadian lumber Saudi Arabian oil

39. Heckscher-Ohlin Model Comparative advantage depends on factor intensity A country will export goods that are intensive in the factors that it has in abundance What is the United States’ comparative advantage? Land Capital Labor Human Capital Bertil Ohlin Eli Heckscher

41. The Market in Autarky Autarky: PA, QA (CS+PS) is maximized $ S1 CS PA PS D1 Autos QA

42. The Domestic Market with Imports PA is the autarky price PW is world price Imports $ S1 A PA B C E PW F D1 Autos QS QA QD Net gain = C+E

43. The Domestic Market with Exports PA is the autarky price PW is world price Exports $ S1 A PW B E C PA G F D1 Autos QD QA QS Net gain = E

44. Trade Protectionism : Import Tariffs PW is world price PW+T includes tariff Imports After tariffs Imports before tariff $ S1 A B PW+T C F E G PW H D1 Autos QS QST QDT QD DWL = E+G

45. Trade Protectionism : Import Quotas PW is world price PW+T includes quota Imports After quota Imports before quota $ S1 A B PW+T C F E G PW H D1 Sugar QS QST QDT QD DWL = E+F+G

46. Cost of Sugar Quota to US Consumers World sugar price = $0.22 per lb. US domestic price = $0.34 per lb. Per capita consumption of sweeteners = 137 lbs US Population = 305 m Elasticity of demand for sugar = - 0.35 Imports After quota $ S1 A B PW+T C F E G PW H D1 Sugar QS QST QDT QD

47. The Politics of Protectionism Arguments for Protectionism National Security Job creation Infant industry argument Special Interest Groups Small, cohesive, groups of producers lobby for political favors at the expense of the majority International Trade Agreements NAFTA European Union WTO