Economic Management #2: Markets, Surplus and Elasticity

[samvara]

Friday night as a time-slot is teh sux0rs but we muddle on.

• Economists like markets because they think the equilibrium achieved in competitive markets results in a maximum total welfare.
  • Consumer surplus measures economic welfare from the buyers side.
    • It is the buyer's willingness to pay for a good minus the amount the buyer actually pays for it - which is a fascinating way to view it and evidence that Economists do not think like the rest of us.
    • It is a measure of the benefit buyers receive from a good based on their preferences and choices.
    • Demand decisions of consumers tell us willingness to pay where this means the maximum amount a buyer will pay for a good, rather than do without it. (Food, health, contraception, education)
  • Producer surplus measures economic welfare from the seller's side

Demand Curve:see pretty graphs!

Consumer surplus graphs and explanation on wikipedia seem pretty decent. In class example indicates men will pay more for for certain goods ... oh fine... indicates if person A will pay $100 for an item and person B will pay $80 for the same item and you sell it at $80 then there is a consumer surplus of $20 - e.g. person A would have spent $100, and only had to spend $80 and therefore technically has an extra $20 of disposable income - surplus!

• As the price goes down, the consumer surplus goes up.

Producer surplus is the amount a seller is paid for a good minus the seller's cost. It measures the benefit to sellers participating in a market.

• As the price goes down, the producer surplus goes down.

Market efficiency: who do economists place such weight on this idea that allocation of resources determined by free markets is desirable? Economists are rampant capitalists?

• maximises the combined consumer surplus and producer surplus (total, not individual)
• maximises social value from the supply and distribution of the good (I question this)

Competitive Markets: maximise total surplus

• allocate the supply of goods to the buyers who value them most highly, as measured by their willingness
• allocate the demand for goods to the sellers who can produce them at least cost
• produce the quantity of goods that maximises the sum of consumer and producer surplus

Demand Analysis

Elasticity is the measure of responsiveness to change (of price). Scale is from -infinity (totally elastic) to -1 (inelastic) to 0 (totally inelastic). Except it's quoted without the negative sign. so umh, the calculation will spit out -1 but we would quote it as 1.

• Perfectly inelastic: land; you can't create more
• Perfectly elastic: lecturer says no examples exist, I would like to propose 'love'

Calculation:

• Elasticity = % change in quantity / % change in price
• Arc Elasticity = % change in quantity / % change in price plus extra maths

NB: No matter how tempting it is, the slope of the demand curve is not a measure of elasticity. Slope is price/quantity.

Some examples of elasticity:

• Toilet paper is inelastic, regardless of price changes people tend to buy the same amounts
• Cigarettes are relatively inelastic, if taxation goes up, people keep smoking
• High end clothing is highly elastic, people buy more if there's a sale
• Regular coffee is inelastic (0.2), people just pay - decaf is slightly less elastic indicating people don't love it as much?
• According to my table (US figures) the hierarchy of dentistry goes men (0.7) women (0.8) children (1.4) - this may be a measure of who has the money rather than who values the treatment though :p

Things wot affect demand when price changes:

1. income - as price falls we tend to buy more
2. substitution effect - 'rational' people switch to a cheaper product

Price Elasticity and Total Revenue
Calculation: Total Revenue = Price x Quantity

• Elastic: Prices goes up, Total Revenue decreases
• Inelastic: Prices goes up, Total Revenue increases

Price Elasticity and Marginal Revenue
Calculation: Marginal Revenue = change in Total Revenue / change in Quantity

• Elastic: Marginal Revenue is positive
• Inelastic: Marginal Revenue is negative

Factors of Price Elasticity

• Availability and closeness of substitutes (the more substitutes, the most elastic)
• Durability of product (longer life, more elastic)
• Proportion to budget (more expensive, more elastic)
• Length of time period permitted (more time, more elastic)

Income Elasticity
Calculation: Income Elasticity = % quantity demanded / % Annual Income

...and then we did practice exercises for an hour and discussed the results.

This mostly involved drawing supply and demand diagrams and predicting how supply or demand or price would change based on various scenarios.

and then we ran away