UBEA 1013: ECONOMICS 1 CHAPTER 3: MARKET EFFICIENCY & ELASTICITY 3.1 The Market System 3.2 Constraint on the Market: Government Intervention 3.3 Market

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UBEA 1013: ECONOMICS

CHAPTER 3: CHAPTER 3: MARKET EFFICIENCY & ELASTICITYMARKET EFFICIENCY & ELASTICITY

3.1 The Market System

3.2 Constraint on the Market: Government Intervention

3.3 Market Efficiency & Surpluses Maximization

3.4 Elasticity

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DD & SS Interaction

Output (Product) MarketOutput (Product) Market

Utility (excluded)Consumer surplusFactors effect DD

Elasticity

ProductionSupplier surplusFactors effect SS

ElasticityMarket structure

Changes in DD / SS:Equilibrium Price &

Quantity

Microeconomics scope for UBEA 1013 Economics

Market SystemMarket Efficiency

Government Intervention

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3.1 The Market System3.1 The Market System

Stability or equilibrium point: supply = demand

This situation achieved and re-achieved after disequilibrium through the an important functions of the market (price system):

PRICE RATIONING

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Price Rationing:Definition: i. Allocates output to consumers and resources to

firms through price adjustment. ii. Price rationing when Qty DD > Qty SS (shortage) iii. Allocation based on willingness & ability to pay

(answering the “for whom to produce” problem).

Figure 3.1: Price Rationing

3.1 The Market System3.1 The Market System

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UBEA 1013: ECONOMICS 3.1 The Market System3.1 The Market System

Note:Price rationing is consider as market oriented approach

because: i. Allocates through open market ii. No government intervention

Weaknesses (market failure): Inability to recognize that each society have the right, necessity or needs to certain type of outputs like health care, accommodation, basic food and safety

Use non-market / non-

pricing approach

lottery approach, political approach and mixed approach

government intervention

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UBEA 1013: ECONOMICS 3.1 The Market System3.1 The Market System

Situations of Market failure:

a) External benefit: i. Free-riders ii. Road (transport), hospital (public health), dam

(flood/electricity)

b) External cost: i. Negative effect/cost to others ii. Pollution

c) Imperfect information: i. Seller has more info than buyer ii. “Lemon market” & info disclosure

d) Imperfect competition: i. Market controlled by monopoly, cartel, illegal co-

operation ii. Government ownership, law & regulation

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3.2 3.2 Constraint on the Market: Case for Government Intervention

a) Price ceiling: i. Maximum price sellers may charge ii. To control unjust high price

iii. Excess demand (Ration coupon as complement action to control DD)iv. Emerging of black market

Figure 3.1 (Price Ceiling at $3.27)

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b) Ration coupon: i. Ticket/coupon entitle individual to purchase ii. Coupons trading – alike price rationing

iii. Serve as redistributing income

3.2 Government Intervention3.2 Government Intervention

c) Favored customer: i. Special treatment ii. Results in hidden cost

d) Waiting in line (Queuing): i. Product cost = cost of waiting ii. A form of deadweight loss

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e) Price floor: i. Minimum price for buying – selling ii. To adjust unfair low price

iii. Excess of supply (government has to buy up excess)iv. Alternative: subsidization

Figure 3.2: Price Floor: Minimum Wages

f) Other restriction: i. Price control ii. Licensing

iii. Taxesiv. Quota

3.2 Government Intervention3.2 Government Intervention

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3.3 3.3 Market Efficiency & Surpluses Maximization

What is “Efficient Market”?:

i. Pareto efficient: A market is efficient if there is no way to make any person better off without hurting anybody else. (Relate to PPF)

ii. Relate to PPF: Reduce production of product “Y” to increase production of product “X”.

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What is “Consumer Surplus”?: i. Extra value individual received ii. What people willing to pay

iii. Maximum amount willing to pay minus current market price

3.3 Efficiency & Surpluses3.3 Efficiency & Surpluses

Figure 3.3: Consumer Surplus

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What is “Producer Surplus”?: i. Extra value producer received ii. What producer pay for the right to sell at current

priceiii. Minimum amount willing to sell minus current market price


Figure 3.4: Producer Surplus

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UBEA 1013: ECONOMICS 3.3 Efficiency & Surpluses3.3 Efficiency & Surpluses

Surplus maximization:

i. Market efficient = maximize sum of consumer & producer surpluses

ii. Achieved when DD = SS

Figure 3.5(a): Surplus maximization

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Deadweight loss: i. Losses of consumer and producer surplus that are

not transferred to other parties ii. Occur from under and over production

Figure 3.5(b): Deadweight loss (under production)

Figure 3.6: Deadweight loss (over production)


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3.4 3.4 Elasticity

A measure of how “responsive” demand is to some change in price or income:

i. The slop of a demand function (∆q/∆p) ii. The slope of the demand curve (∆p/∆q)

iii. Elasticity method

2 3 1slope

10 5 5

2 3 1

slope160 80 80

Figure 3.5(a): Demand Curve Slope & Responsiveness

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UBEA 1013: ECONOMICS 3.4 Elasticity3.4 Elasticity

Elasticity is a general concept to:

i. quantify the response in one variable when another variable changes

ii. measure the percentage change in one variable brought about by a 1 percent change in some other variableiii. Elasticity is unit free

Type of elasticity: i. Price elasticity of demand ii. Income elasticity

iii. Cross-price elasticity

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Price elasticity of demand calculation: How responsive consumers are to changes in the price of a product

ε = [(∆q/q)*100%] / [(∆p/p)*100%] ………… (Equation 3.1)

= (∆q/q)*100% * (p/∆p)*(1/100%)

ε = (p/q)*(∆q/∆p) …………… (Equation 3.2)

Ratio of price to quantity

multiply

Slope of demand function

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Example: Use Figure 3.7 (a) & (b). Assumed price decrease from P1 = $3 to P2 = $2.

ε = (p/q)*(∆q/∆p) …………… (Equation 3.2) = (3/5)*[(10 – 5)/(2 – 3)] = – 3

or

For Figure 3.7 (a):

Same answer for Figure 3.7 (b): proving that different unit of measurement did not effect elasticity.

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BUT different answer if assumed price increase from P1 = $2 to P2 = $3.

Solution: Mid-point formula

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NOTE: Which one is more elastic?

– 5 – 4 – 3 – 2 – 1

More elastic Less elastic

1 2 3 4 5

Less elastic More elastic

In absolutevalue

In negativevalue

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Figure 3.8(a): Perfectly Inelastic Figure 3.8(b): Perfectly Elastic

Table 3.1 shows values & types for elasticity of demand

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Elasticity of linear demand curve: i. Change from point to point ii. Decrease when move downward

iii. Elastic at upper range, inelastic at lower range

Figure 3.9: Elasticity of a Linear Demand Curve

At middle point, elasticity = 1

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Calculus proving (No. 1):

ε = (p/q)*(∆q/∆p) …………… (Equation 3.2) = (p/q)* (– b) = [p / (a – bp)]* [– b] (›› q = a – bp)

– 1 = [p / (a – bp)]* [– b] (unitary elasticity)– 1 = (– bp) / (a – bp) bp = (a – bp)2bp = a p = a / 2b (middle point)

Consider a linear demand curve, q = a – bp i. The slope = – b ii. If q = 0; p = a / b (price intercept)

p = a / b

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p = a / b

Linear demand curve, q = a – bp At price axis intercept, q = 0 & p = a / b

ε = (p/q)*(∆q/∆p) …………… (Equation 3.2) = [(a/b) / 0]* (– b) = ∞ (›› infinity elasticity at price intercept)

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p = a / b

Linear demand curve, q = a – bp At quantity axis intercept, p = 0 & q = a

ε = (p/q)*(∆q/∆p) …………… (Equation 3.2) = (0/a)*(– b) = 0 (›› zero elasticity at qty intercept)

a

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Price increase > Qty drop›› increase price = increase revenue

Price increase < Qty drop›› increase price = reduced revenue

Price increase = Qty drop›› revenue maximization

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Cross price elasticity: Measure of the response of the quantity of one good demanded to a change in the price of another good

ε = [(∆q/q)*100%] / [(∆p’/p’)*100%]

For substitute product: ε(p’) positive (the price of one product and

quantity demanded for another product move in the same direction)

For complement product: ε(p’) negative (the price of one product

and quantity demanded for another product move in the opposite direction)

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Elasticity of labor supply is a measure of the response of labor supplied to a change in the price of labor

Elasticity of supply is a measure of the response of quantity of a good supplied to a change in price of that good. Its value is likely to be positive in output markets due to the law of supply.

Others elasticity:

End

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UBEA 1013: ECONOMICS 1 CHAPTER 3: MARKET EFFICIENCY & ELASTICITY 3.1 The Market System 3.2 Constraint on the Market: Government Intervention 3.3 Market