Principles of Economics
Principles of Economics

Principles of Economics

Lead Author(s): Stephen Buckles

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Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

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Pricing

Average price of textbook across most common format

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Up to 40-60% more affordable

Lifetime access on any device

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

$130

Hardcover print text only

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

$175

Hardcover print text only

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

$140

Hardcover print text only

Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

All-in-one Platform

Access to additional questions, test banks, and slides available within one platform

Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

About this textbook

Lead Authors

Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

Contributing Authors

Benjamin ComptonUniversity of Tennessee

Caleb StroupDavidson College

Chris CotterOberlin College

Cynthia BenelliUniversity of California

Daniel ZuchengoDenver University

Dave BrownPennsylvania State University

John SwintonGeorgia College

Michael MathesProvidence College

Li FengTexas State University

Mariane WanamakerUniversity of Tennessee

Rita MadarassySanta Clara University

Ralph SonenshineAmerican University

Zara LiaqatUniversity of Waterloo

Susan CarterUnited States Military Academy

Julie HeathUniversity of Cincinatti

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Chapter 5: Using Supply and Demand

Figure 5.1: People lining up for the new iPhone release at an AT&T store on Broadway. [1]​

The Law of Demand is often used by policymakers to achieve public policy goals. For example, Cook County, IL, became the largest area in the nation to enact a tax on sugary and artificially sweetened drinks in 2016. When the tax goes into effect in 2017, it will increase the tax on 7-Eleven’s Gulp to 32 cents and the Double Gulp to 50 cents. Policymakers hope this will lead to lower consumption of sugary drinks and reduce the prevalence of diabetes and obesity in their community. In addition, the county expects this increased tax to add $224 million to revenues.

Figure 5.2: A 32 oz. Big Gulp Advertisement from 7-11​ [2]

5.1 Objectives

After completing this chapter, you will be able to:

  • ​Understand the concept of elasticity when applied to demand and supply.
  • Explain why some goods’ demand is elastic while others’ demand is inelastic.
  • Forecast the effects of changes in prices on producer revenues.
  • Explain how price floors and ceilings affect equilibrium prices and quantities.
  • Discuss the benefits and costs of price controls such as a minimum wage for labor or a maximum price for gasoline.
  • Use supply and demand analysis to explain how taxes affect equilibrium prices and quantities.

5.2 Price Elasticity of Demand

​Suppose you are thinking of working next summer to design web pages for local businesses. You know that at the price you have been thinking about – $400 per web page – you will not be busy all summer, but you will sell some web pages. Should you raise the price you charge per page or lower it?

​Suppose that your goal is to earn as much income as you can over the summer. If you decide to increase your price, the law of demand predicts that the quantity demanded for web pages will fall. You will receive more revenue per page but sell fewer pages. If you lower your price, you know that you will sell more pages. You will receive less per page, but sell more of them.  

How do you earn more income or revenue? It comes down to which is greater – the effect of the change in price or the effect of the change in quantity. If the additional revenue you make from increasing the price is greater than the loss from the fewer pages sold, total revenue increases. However, if the additional revenue gained from higher prices is less than the losses from fewer pages sold, total revenue will fall. A similar outcome happens when you decrease price. If the revenue you lose from lowering the price is greater than the increase in pages you sell, then your total revenue will fall. If your lost revenue from the price reduction is less than the gain in the number of pages you sell, then your total revenue will increase.

​Clearly, the most important factor in determining total income or revenue is the relative size of the effect of the change in prices on the number of web pages sold. If the change in price causes a relatively large change in the quantity demanded, we describe demand as being elastic. Technically, we compare the percentage change in quantity demanded with the percentage change in price. Forgot how to compute a percentage change?


​A change in price that causes only a small change in quantity demanded is characteristic of inelastic demand – that is, the quantity demanded is not very sensitive to change in price. Specifically, if the percentage change in quantity demanded is less than the percentage change in price, we describe demand as being inelastic.

​So how will you know whether the demand for your web pages is going to be inelastic or elastic? Could you predict whether demand would be elastic or inelastic? One method would be to experiment, but by the time you found out, the summer might be over. Alternatively, we could look at what determines elasticity and make a forecast.

Question 5.01

Question 5.01

List some things that influence how sensitive you are to changes in the prices of goods and services you purchase.

Hover here to see the hint for Question 5.01.
Click here to see the answer to Question 5.01.

5.3 What determines the Elasticity of Demand?

Your list might include the following characteristics:

5.3.1 Number of Substitutes

The greater the number of substitutes, the easier it is to switch from the consumption of one good to another in response to a price increase or decrease. Therefore, the greater the number of substitutes, the greater the elasticity is likely to be. Demand for gasoline is likely to be inelastic, as there are not very many substitutes for it, but the demand for Honey Bunches of Oats® is likely to be more elastic since there are a lot of other cereals to choose from. 

5.3.2 Whether or not a Good is a Necessity

Prescribed medicine is an example of a good that is a necessity. We will be less sensitive to changes in prices of prescribed medicine than we might be to changes in prices of movie tickets. This is really a special case of the effects of the number of substitutes. A luxury is likely to have a number of substitutes; a necessity has very few. An absolute necessity is actually an extreme example of the case where there are very few substitutes, perhaps even no substitutes. 

5.3.3 Percentage of Income Spent on Good

If the amount spent on a good makes up a large part of one's income, then that person will likely be more sensitive to a change in price than if the amount spent is a small portion of her income. If you drive very little, your demand for gasoline is likely to be less elastic than someone who drives long distances to work every day and spends a significant portion of their income on gasoline. If the price of chewing gum increases, you would be likely to change your consumption by a very small amount. In this case, demand is inelastic.

5.3.4 Length of Time for Adjustment

The more time we have to adjust to a price change, the more elastic demand will be. That is, given time, we can identify substitutes or learn to live without goods. Gasoline is a good example. Demand over periods of a few weeks or months is relatively inelastic. You have to get to work, and you may not know of any easily available alternatives to using an automobile. However, if you are given time to identify substitutes like car pools or public transportation, you will probably be more sensitive to the price of gasoline. For this reason, demand is typically more elastic over longer periods of time. 

5.4 A Test of Understanding

Question 5.02

Rank the following from the least elastic (most inelastic) to most elastic.

A

Demand for dessert

B

Demand for food

C

Demand for Oreos

D

Demand for cookies

Question 5.03

Question 5.03

Compare the likely elasticity of demand for a college education with the likely elasticity of demand for a degree at one specific institution.

​Hover here to see the hint for Question 5.03.
Click here to see the answer to Question 5.03.

Question 5.04

Is the demand for a container of salt likely to be inelastic or elastic? Why?

A

Inelastic because salt is a necessary dietary component

B

Elastic because there are lots of substitutes for salt

C

Inelastic because for most people salt is a very small part of their budget

D

Elastic because people only buy salt in the long-run

5.5 Will Total Revenue for a Business Rise or Fall When its Prices Change?

Figure 5.3: Revenue Drawn by a Blue Marker​ [3]

At the beginning of this chapter, there was a question about a summer job designing web pages. What should a person or firm do if the goal is to increase the total revenue or total income of your businesses and you can only vary the price? It clearly (or at least should be “clear” soon) depends upon the elasticity of demand facing the firm.

Total revenue equals the quantity sold (the same as the quantity demanded) times the price of the good. The law of demand tells us that if the price is lowered, the quantity demanded increases and vice versa. So the answer to the question of whether one should raise or lower price depends upon which effect on revenue is the largest. That is, does the increase in revenues from the higher prices outweigh the decrease in revenues from the corresponding loss in quantity sold? 

As stated above, the formal definition of the price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. If that number is greater than one (the percentage change in quantity demanded is greater than the percentage change in price), demand is elastic. If the price elasticity of demand is less than one (the percentage change in quantity demanded is less than the percentage change in price), demand is inelastic. By now, you might have asked yourself what happens if the elasticity of demand is exactly equal to one (good question!). There’s a name for that, too – if the elasticity of demand is equal to one, that is called unitary elasticity. 

Think about a simple example. Suppose a retail store is currently selling 100 iPods per week. The price of each one is $200. If the price were increased by 10 percent and the quantity demanded decreased by 5 percent, then demand is inelastic – the percentage increase in price was greater than the percentage decrease in quantity. If the price were increased by 10 percent and the quantity demanded decreased by 15 percent, demand is elastic. If the quantity demanded decreased by 10 percent due to a 10 percent change in price, that would indicate a unitary elasticity. 

Question 5.05

Question 5.05

What would happen to the store’s total revenue with this 10 percent price increase if quantity falls by 5 percent?

Hover here to see the hint for Question 5.05.
Click here to see the answer to Question 5.05.

Question 5.06

Question 5.06

If demand were elastic, an increase of 10 percent in the price might cause a 20 percent decrease in quantity demanded. What would happen to the total revenue in this case?

Hover here to see the hint for Question 5.06.
Click here to see the answer to Question 5.06.

Question 5.07

A business should ___________ (increase/decrease) the price of a good with an inelastic demand if it wants to increase revenues.

A

Increase

B

Decrease


Question 5.08

A business should ___________ (increase/decrease) the price of a good with an elastic demand if it wants to increase revenues.

A

Increase

B

Decrease

We can see these relationships graphically:


Figure 5.4: A decrease in price creates a decrease in revenues.​​​

A fuller explanation of why the demand curves in these two examples are of different slopes will be given below, but as a general rule, an inelastic demand curve will be steeper than a demand curve that is elastic. An inelastic demand with a given percentage decrease in the price will cause a smaller percentage increase in the quantity demanded. As a result, total revenue will fall. The firm loses revenues from the decrease in price and gains revenues from the increase in quantity, but the gain is going to be less than the loss. Figure 5.4 shows the loss in revenues resulting from the decrease in the price. It is the amount of the decrease in the price times the current quantity sold. The gain in revenue is the new price times the increase in the quantity demanded. In this case, the size of the loss is greater than the size of the gain.

Figure 5.5: A decrease in price creates an increase in revenues​​.

With a different demand, one that has a much larger increase in the quantity demanded resulting from the same price decrease (an elastic demand), the results will be just the opposite. Figure 5.5 shows the same initial price and same initial quantity, but this time the quantity demanded is much more sensitive to the price decrease. The loss in revenue from the price drop is the same – the decrease in price times the current quantity sold. As the price decreases, the gain in revenues from the increase in quantity demanded is much greater, because the increase in the quantity demanded is much larger than the decrease in price. An elastic demand means that a decrease in price increases total revenue. The loss in revenue is the same as with the inelastic demand, but the gain in revenue is much larger.

Graphing Question 5.01

Graphing Question 5.02


Question 5.09

Assume that the elasticity of demand is 1.6. Is demand elastic or inelastic?


Question 5.10

If you were selling a product with an elasticity of 1.6 and you wanted to increase your revenue, what should you do to the price?

A

Lower price

B

Increase price

C

Do not change price


Question 5.11

Suppose you know that the price elasticity of demand for your product is 0.5, and you are thinking about raising your price by 8%. How much can you expect quantity to decrease?

A

8%

B

5%

C

4%

D

We can't tell how much quantity will decrease.


Question 5.12

A major city was thinking about increasing its bus fares and commissioned a study to estimate the price elasticity of demand. The study estimated that elasticity was 0.4. What action should the city have taken to increase revenue from bus fares?

A

Increase fares

B

Decrease fares

C

Do not change fares

Question 5.13

Question 5.13

In the question above, two years after the city raised fares, it noticed that revenues were decreasing. What could have happened over the two years to cause consumers to be more sensitive to the higher fares?

Hover here to see the hint for Question 5.13.
Click here to see the answer to Question 5.13.

Question 5.14

In the question above, if the city examined the elasticity of bus fares over this longer time period, what would they likely find?

A

Elasticity is now greater than 1

B

Elasticity is now less than 1

C

Elasticity is 0

5.5.1 A Numerical Example

Suppose we have two different demand relationships – one describes demand for movies in the winter and the second describes the demand in the summer in Kansas City. Suppose the initial price is $8.00 for movies in the winter and in the summer. Should movie theaters raise or lower prices in the winter or in the summer, if the goal is simply to increase total revenues?

Question 5.15

Prices should be ___________ (increased/decreased/not changed) in the winter and ___________ (increased/decreased/not changed) in the summer.

question description
A

Increased; increased

B

Decreased; decreased

C

Increased; decreased

D

Not changed; decreased

Question 5.16

Question 5.16

Why might demand for movies be more elastic in the summer than in the winter?

Hover here to see the hint for Question 5.16.
Click here to see the answer to Question 5.16.

Question 5.17

Question 5.17

Explain in your own words what it means for demand to be elastic or inelastic.

Hover here to see the hint for Question 5.17.
Click here to see the answer to Question 5.17.

5.5.2 The Logic 

One way to grasp the relationship between changes in total revenues, changes in prices, and elasticities is to think carefully about the formal definition of elasticity. 

A good or service with an inelastic demand – that is, a price elasticity of demand less than one – has a percentage change in the quantity demanded that is smaller than the percentage change in the price of the good. Thus, if the price is decreased, the loss in total revenue resulting from the price decrease is going to be greater than the gain in total revenue resulting from the increase in quantity demanded. 

It can be approximated as follows. Think of a potential demand for iPods. An Apple store sells 100 iPods for $200 each week. If demand were inelastic, it might face a demand that for each 10 percent change in price, there will a 5 percent change in quantity. Thus, with a price decrease, the store loses approximately 10 percent of its revenues and gains approximately 5 percent. Total revenues fall. 

A rise in price would cause an approximately 10 percent gain in revenues from the higher price and a 5 percent fall in revenues from the fewer iPods sold. Total revenues would thus rise. 

With an elastic demand, the gains from an increased price would be outweighed by the losses from the lower quantities. The losses from a decreased price would be outweighed by the gains from the higher quantities. 

Table 5.1: Price Elasticities of Demand​​

We know what happens to revenue when price changes under the two elasticity conditions, but what about profit? Remember that profit is total revenue minus total cost. Also, remember that quantity and costs will increase or decrease together; e.g., if quantity decreases, costs must also decrease. Now you’re ready to answer the next question.

Question 5.18

Assume demand is inelastic. Click the corresponding arrows to indicate how quantity, revenues, costs, and profit will be affected if prices are increasing or decreasing.


Question 5.19

Assume demand is elastic. Click the corresponding arrow to indicate how quantity, revenues, costs, and profit will be affected if prices are increasing or decreasing. If there is not enough information to tell, do not select an answer for that section.

5.6 What Does it Mean to Say That Demand is Perfectly Elastic or Perfectly Inelastic?

Do not make the mistake of thinking that inelastic demand (or, for that matter, inelastic supply—we’ll get to that later) means that the quantity demanded does not change at all in response to a change in price. The quantity demanded does change, but just not by as much as it would if demand were elastic.

An exception is when demand is perfectly inelastic. In this case (an unusual one), price changes do not affect the quantity demanded at all. Another exception is when demand is perfectly elastic. A price change affects the quantity demanded by as much as possible. For example, in this case, a price increase would not just cause the quantity demanded to decrease – the quantity demanded would fall to zero.

What does it mean if a good is perfectly (or completely) inelastic or elastic? Try to think of some real-world examples that approximate perfectly inelastic and elastic goods. Do these violate the law of demand? The short answer is: yes! With perfectly inelastic and elastic demand curves, price and quantity do not have an inverse relationship, as you will see below.

Figure 5.6: Prescription Insulin [4]​

Insulin is a good example of perfectly inelastic demand, at least for ranges of prices close to current prices and for individual consumers. For diabetics, it is a necessity or at least viewed as such. The price of insulin can increase within a range and diabetics will still purchase it. If price falls within a range, they will not buy more of it – their dosage will stay the same. It is possible that if price increases enough, consumers will start to look for other options: they could watch their diets more closely, or they could try other medications that might help lower their blood sugar. They may even stop buying it altogether and risk suffering the side effects of untreated diabetes. But within a range of prices and for most consumers, the quantity sold of insulin will be very insensitive to the price


Figure 5.7: A Perfectly Inelastic Demand Curve​


Figure 5.8: A Perfectly Elastic Demand Curve​


Question 5.20

Is Figure 5.7 in violation of the law of demand?

A

Yes

B

No

5.6.1 Other Elasticities

A change in price will cause a change in quantity demanded – technically defined as the price elasticity of demand. But there are several different types of elasticity other than the elasticity of demand we have been discussing. In general terms, the concept of elasticity relates changes in one variable to changes in a related variable. 

For example, a change in price will also cause a change in the quantity supplied – the price elasticity of supply. Like with price elasticity of demand, an elastic measure means that a change in price causes a relatively large change in quantity supplied. An inelastic measure means that the change in price causes a relatively small change in the quantity supplied. Similar to price elasticity of demand, if the price elasticity of supply is elastic, that means that producers respond to price changes by greatly changing the quantity they produce and sell. If the price elasticity of supply is inelastic, then producers will not change the quantity they provide to the market by very much when price changes. Because with the supply curve, price and quantity both change in the same direction, the sign of the elasticity of supply will always be positive, just like the sign of the elasticity of demand will always be negative.

5.6.1.1 Factors Influencing Price Elasticity of Supply

The primary influence on the price elasticity of supply is the ability of the producer to increase production. If the market price increases and producers can respond by easily (relatively cheaply) producing more, then the supply is elastic. But if they cannot easily (cheaply) increase how much they produce, then they will not be able to respond to this price increase as much, making price elasticity of supply relatively inelastic

For example, if demand increases for clothing and its price goes up, the quantity supplied of clothing can be relatively easily increased because the costs of inputs and labor are unlikely to increase significantly. We would describe this supply as elastic because significant increases in output (in response to a price increase) can be gained with relatively small increases in costs.

But now think about oil. To get oil producers to find, retrieve, and refine additional oil may require considerable effort at a higher cost than the oil that is already located and refined. In this case, an increase in the market price will result in much smaller increases in output, and supply will be relatively inelastic. 

A related factor is the amount of time we allow producers to respond. In very short periods of time, producers will find it difficult to locate new employees and expand capacity. Supply is likely to be inelastic. However, if producers are allowed more time, they may be able to identify ways of increasing output without significant increases in costs of producing. In this case, supply will tend to be more elastic. 

Graphing Question 5.03

Graphing Question 5.04

5.6.1.2 Income Elasticity

We have seen that the sign of elasticity measures varies according to whether we are talking about price elasticity of demand or supply. With demand, the elasticity measure will always be negative; with supply, it will always be positive. But income elasticity of demand is a special case where the sign of the elasticity varies. Think about the case where the income elasticity would be positive. That means that as income increases, so does the demand of a good. Sound familiar? We learned about these goods in the previous chapter – if the income elasticity of demand is positive, the good is a normal good. Most goods will have a positive income elasticity – think of computers, movies, or vacations. 

If, as a result of rising income, the demand decreases, then the income elasticity of demand will be negative. We call this an inferior good. Used cars and clothing, inexpensive small apartments, and certain foods such as rice and potatoes are examples of inferior goods.

Luxuries are a special case of normal goods and have an income elasticity that is not only positive but greater than one. Exotic vacations, sports cars, second homes, crystal and china, and meals in restaurants all may fall into this category.  

Question 5.21

Question 5.21

If there is a drought, what would you expect to happen to farmers' revenues?

Hover here to see the hint for Question 5.21.
Click here to see the answer to Question 5.21.

Question 5.22

Question 5.22

If a good has an income elasticity of 0.8, what do you expect to happen to the quantity demanded of this good if the country enters a recession?

Hover here to see the hint for Question 5.22.
Click here to see the answer to Question 5.22.

Question 5.23

Question 5.23

Which product is more likely to have an elastic supply: ice cream or diamonds?

Hover here to see the hint for Question 5.23.
Click here to see the answer to Question 5.23.

Question 5.24

Sometimes consumers purchase goods because of “conspicuous consumption”; i.e., they want others to know that they can afford to buy the goods. There are many examples of these goods, such as Rolex watches, Coach purses, and flying first class. What would you expect the income elasticity of demand to be for these goods?

A

These are luxury goods, so income elasticity would be greater than 1.

B

These are normal goods, so income elasticity would be greater than 1.

C

These are inferior goods, so income elasticity would be greater than 1.

5.7 Price Ceilings and Floors

A competitive market forces prices and quantities toward equilibrium levels. We have discussed how markets make the quantity demanded equal the quantity supplied, how suppliers respond to buyers’ demands, and even how the outcome will be economically efficient. However, there are times when the equilibrium price and quantity are not satisfactory either to the producers, consumers, or lawmakers. In such cases, prices can be set at levels which may be more desirable to some than the equilibrium price. In our economy, we have seen rent controls used in major cities to hold down rents, maximum gasoline prices in the 1970s oil crises, freezes on all prices during a period in the 1970s, and interest rate ceilings in some states. In addition, we use minimum wage laws both nationally and in specific states and cities, and price floors on many agricultural products. We will look at two possible alternatives to the equilibrium price, why they would be enacted, and their consequences. 

A price ceiling is a legal maximum price. The law states that the price of a particular good or service may not legally exceed a specified level. It is described as a price ceiling because the price may not go higher than the ceiling. In Figure 5.9, the equilibrium price for pizza is $10, and the equilibrium quantity is 50 pizzas. Imagine that the consumers who are either currently buying pizza or who want to buy pizza are successful in persuading lawmakers that the price of $10 is too high. Lawmakers respond by enacting a price ceiling at $7, meaning that no one can legally sell or buy pizza for more than $7. What will happen in this market? Well, we know what the price will be: it is $7. But what quantity will be exchanged in this market? At a price of $7, consumers are very enthusiastic – they want to buy 65 pizzas. But at a price of $7, producers are less enthusiastic about participating in this market, and they only want to sell 40 pizzas. How much will be exchanged? Since all exchanges are voluntary, the amount that producers want to provide to the market is the amount that consumers will be able to buy; no one can force producers to make more. So even though consumers want many more units than 40, they won’t be able to buy them. The result is a shortage of 25 pizzas (65 minus 40). When shortages exist, a black market (an illegal market) often opens up because there are people who are willing to pay a higher price than the price ceiling. 

Figure 5.9​: Market for Pizza with Price Ceiling

Graphing Question 5.05

Graphing Question 5.06

If a price ceiling results in a shortage, why would anyone want it? The consumers who are still able to buy pizzas now do so at a lower price than the equilibrium price. The flip side of this, though, is that some consumers who used to be able to buy pizzas now will not be able to (50-40 or 10 fewer pizzas will be exchanged). Remember that the function of a market price is to allocate goods to consumers who are able and willing to buy. When a price ceiling is imposed, some consumers who are able and willing to buy at the equilibrium price will not be able to do so. Therefore, some other way must be imposed to allocate pizzas. 

Price ceilings on gasoline were put into effect in the late 1970s because successive oil embargos drove the equilibrium price of gas very high. In an effort to soften the blow of this large price increase, the government placed a price ceiling on gas, resulting in significant shortages. Many states adopted an odds/evens method of allocating the gas. If your license plate ended in an odd number, you could only buy gas on certain days of the week; even plate numbers could buy on the other days. Some states restricted how much gas you could buy at a time. Regardless of the allocation plan, when price ceilings are imposed, some method of managing the resulting shortage must be in place. 

Question 5.25

Question 5.25

Look at this graph, where the price ceiling is placed above the equilibrium price. Show the quantity supplied and the quantity demanded. Describe the situation.

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Click here to see the answer to Question 5.25

A price floor is a minimum price set by law or regulation. In this case, the law states that prices of specific products or resources may not be below a set amount. That is, the price may not fall below the floor. A price floor is also called a price support and is used extensively in agricultural products. 

To be effective, the level of the minimum price must be such that prices are higher than they otherwise would be. The minimum price must be above the equilibrium price. 

To see the effect of a price floor, look at Figure 5.10. We return to our market for pizzas, but this time, the producers of pizza have been successful in getting legislation passed that mandates that the price of pizza cannot fall below $12. Now what is the market’s reaction? 

Figure 5.10: Market for Pizza with Price Floor​

​We see that at the equilibrium price of $10, 50 pizzas were exchanged. If price cannot fall below $12, however, consumers only want to buy 40 pizzas. Even though producers are willing to supply 65 pizzas to the market, they cannot force consumers to buy them, so again, only 40 pizzas will be exchanged. This means that there is a surplus of 25 pizzas, a result that is opposite that of a price ceiling. Again, since the function of price is to allocate goods and services, interference in this market with a price floor means that some other way needs to be found to allocate these extra pizzas.

Graphing Question 5.07

Graphing Question 5.08

The terms price ceiling and price floor can be somewhat misleading. In order to overcome the confusion, picture the price ceiling as an actual ceiling in a room. The price may bump up against the ceiling, but the price cannot go above it. This ceiling is only effective if the equilibrium price lies outside the room and above the ceiling. If the equilibrium price were to be below the ceiling – that is, in the room to begin with – the ceiling would not be effective. A price floor can be thought of in a similar way. If the equilibrium price is in the room already, above the price floor, it is not effective. It is only effective if the equilibrium price is below the floor. In this case, the price might sink down to the floor, but the floor keeps it from going to the equilibrium level. 


Question 5.26

If the government imposes an effective price ceiling in a market, what will be the result?

A

Equilibrium

B

A surplus

C

A shortage

D

Demand will shift left and supply will shift right


Question 5.27

This table shows the supply and demand for socks. If the government imposes a price floor of $10, how many pairs of socks will be exchanged on this market?

question description
A

10

B

5

C

6

D

8

E

2


Question 5.28

Using the table above, if the government imposes a price floor of $10, what will the effect be?

A

A shortage of 6 units

B

A surplus of 6 units

C

A surplus of 8 units

D

A shortage of 2 units

5.8 Case Study

Figure 5.11: A Cow in the Fields​ [5]


NMPF Applauds Expansion of Dairy Price Support Program to Help Farmers [1]

"Five weeks after the National Milk Producers Federation asked for additional economic assistance for struggling dairy farmers, the U.S. Department of Agriculture has agreed to expand the Dairy Product Price Support Program in a way that should boost farm-level income.

In a decision announced Friday by Agriculture Secretary Tom Vilsack, the USDA said it will temporarily increase purchase prices for cheese and nonfat dry milk. The prices will rise from $1.13 per pound for block cheese to $1.31; barrel cheese, from $1.10/lb. to $1.28; nonfat dry milk powder, from $0.80/lb. to $0.92." [...]

                    -National Milk Producers Federation, July 31, 2009


Question 5.29

Click on the graph that best represents an effective price floor.


Question 5.30

Select the graph that best represents the effects in the milk market after an increase in the price of a substitute for milk.

Question 5.31

Question 5.31

Would you recommend a price floor in this case? What is economically efficient? What is fair?

Hover here to see the hint for Question 5.31.
Click here to see the answer to Question 5.31.

Figure 5.12: Skyline Picture of Santa Fe [6]​


Living in Santa Fe [2]

In 2003, Santa Fe passed a "living wage" ordinance that required private businesses with more than 25 employees to pay at least $8.50 an hour (increasing to $10.50 by 2008). The ordinance stands in contrast to the federal minimum wage which at the time was $5.15/hr.

"The laws of economics suggest that the consequences will not be what this law's proponents expect. Companies with 30 or 35 employees will lay off staff to get below 25. Others will let go of their least-skilled workers and demand more from those who remain. More than a few will leave town or refuse to expand. [...]The real wages of this policy, as everywhere it's been imposed, will be fewer lower-income workers with jobs."

                          -The Wall Street Journal, July 9, 2004

Question 5.32

Question 5.32

The Santa Fe minimum wage rose to $11.80 an hour in March, 2019. Describe how you would draw the supply and demand diagram.

Hover here to see the hint for Question 5.32.
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Question 5.33

Question 5.33

What are the arguments in favor of raising the minimum wage? Against?

Hover here to see the hint for Question 5.33.
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Question 5.34

Question 5.34

Use supply and demand to support the arguments.

Hover here to see the hint for Question 5.34.
Click here to see the answer to Question 5.34.

5.8.1 What is Good and What is Bad About Price Ceilings? 

Consider rent controls – maximum prices that can be charged for apartments in major cities. Think of an effective rent control price and evaluate the costs and benefits.

Figure 5.13: Supply, Demand, and Equilibrium

A shortage will develop. By looking at a supply and demand graph, we should see that an effective price ceiling causes the quantity demanded to exceed the quantity supplied (See Figure 5.9)  At the equilibrium price, quantity supplied equals quantity demanded. Thus, if price is set below equilibrium, then more renters will surely enter the market, and some owners will eventually get out of the market. The result is a shortage. 

The quantity supplied in the market will be less than the equilibrium quantity. At that lower quantity, the rent people are willing to pay is greater than the rent that owners are able to charge ). Too little housing is being produced for economic efficiency. The people who can get cheaper rents will benefit. Those who would have been able and willing to pay the equilibrium rent but who will now not get an apartment due to the shortage will lose. 

5.9 Taxes and Subsidies

Imposing price ceilings and floors are two methods that distort the equilibrium price and quantity. Taxing or subsidizing a good or service also results in outcomes that would not otherwise exist.

Historically, various taxes have been placed on cigarettes to discourage smoking, particularly among teenagers. The hope is that with the addition of such a tax, younger people will choose not to begin to smoke. Similar taxes are placed on alcohol, earning the collective name “sin” tax. If a “sin” tax is placed, one objective is to discourage consumption; the other objective is to raise government revenue.

Figure 5.14: A Package of Newport Cigarettes​ [7]

5.9.1 A Tax on a Specific Good

Assume a current price of $4.00 per pack and that the market for cigarettes is in equilibrium. Congress is discussing a tax of $1.10 per pack on producers. 

Question 5.35

Question 5.35

Think about supply and demand curves for cigarettes without the tax. Now assume that the tax will be enforced through the producers paying the government $1.10 for every pack of cigarettes sold. If the tax were added, what would happen to the price and quantity?

Hover here to see the hint for Question 5.35.
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Figure 5.15: Without any tax, equilibrium is at $4.00.​​

​Producers will need $1.10 more at each quantity supplied to be willing to continue producing the original quantities. Another way to consider the change is that producers will cut production if prices do not change. As a result, at the current price, there will be a shortage.

Figure 5.16: With a tax of $1.10, equilibrium is at $4.75.​​

​​​Prices will begin to increase. Quantity demanded decreases and quantity supplied increases. An equilibrium is reached at a price that is the original price plus a portion of the $1.10. In Figure 5.16, the new equilibrium price is $4.75, a 75-cent increase from the original, equilibrium price. But wait, the tax was $1.10 – the government is expecting to receive $1.10 for each unit sold. Who pays that? The producer pays the other 35 cents of this tax. Before the tax, producers got $4.00 per unit; now they will get $4.75. But the producer has to send $1.10 to the government, 75 cents of which they will get from consumers, leaving 35 cents more that producers will lose. Therefore, even though the tax is levied on the producers, consumers pay part of it. 

Figure 5.17: The Market After the Implementation of Tax​​


Table 5.2: The Effect of a Tax on Prices​​

​What does the government receive as tax revenue? The government gets $1.10 per unit sold. This amount sold is less than the original equilibrium amount due to the tax. Under what conditions would the government get more tax revenue? You should recognize that this is a question about how responsive consumers and producers will be to price changes. Would tax revenues be more with an elastic or inelastic demand curve? 

Question 5.36

Question 5.36

Who really pays the tax? Is the elasticity of demand relevant here? What do you expect to be the difference between the elasticity of demand for cigarettes between teenagers and adults?

​Hover here to see the hint for Question 5.36.
Click here to see the answer to Question 5.36.

If the demand curve is inelastic, then more of the $1.10 tax can be passed along to consumers. In our example above, 75 cents of the tax was passed along, but if consumers were even less sensitive to price changes, then more of the tax will be paid for by consumers and less by producers. And tax revenue acts the same as business revenue – if demand is inelastic, an increase in the price leads to an increase in revenue, regardless of who gets that revenue. Conversely, the more elastic the demand curve, the more responsive consumers will be to the price increase that comes with the tax, the quantity demanded will fall and the less the increase in revenue to the government.  

If adults are more addicted to smoking than teenagers are, we would expect teenagers’ demand to be more elastic (or less inelastic) than adults’ demand. According to research, one estimate is that for every 10 percent increase in price, the quantity of cigarettes purchased by teenagers will fall by 7 percent. This decrease in purchases is considerably more than it is with adults, for whom a 10 percent increase results in a 4 percent decrease in quantity demanded. Therefore, tax revenues collected from sales of cigarettes to teenagers would be less than the revenues collected from the sale to adults. 


Question 5.37

Situation A: When a $10 per unit tax is imposed on the producer of Bippies (a candy), the equilibrium price increases by $4. Situation B: When a $10 per unit tax is imposed on the producer of Bippies, the equilibrium price increases by $2. Based on the two situations above, Bippies in Situation A has a _________ elastic supply OR faces a _________ elastic demand than exists in Situation B.

A

More; more

B

More; less

C

Less; less

D

Less; more

Graphing Question 5.09


Question 5.38

If the government taxes car producers, that will happen in the market for cars?

A

The supply curve will shift to the left.

B

The demand curve will shift to the right.

C

There will be a movement along the supply curve to the left.

D

There will be a movement along the demand curve to the right.


Question 5.39

Suppose that there is currently a $2.00 per bottle tax on vodka that is levied on consumers. Legislators have decided to give consumers some relief by eliminating the tax. In order to keep tax revenues at their previous level, they decide to impose a $2.00 tax on producers. What is the net impact of these two actions?

A

Consumers of vodka are made better off.

B

Producers of vodka are made better off.

C

The government is made better off.

D

There is no change in either consumers' or producers' well-being.


Question 5.40

When the federal government subsidizes higher education in the form of Pell grants to students, it results in

A

An increase in the supply of higher education

B

A decrease in the supply of higher education

C

An increase in the demand for higher education

D

A decrease in the demand for higher education


Question 5.41

When the federal government subsidizes higher education in the form of direct subsidies to universities, it results in:

A

An increase in the supply of higher education

B

A decrease in the supply of higher education

C

An increase in the demand for higher education

D

A decrease in the demand for higher education

Graphing Question 5.10

5.10 A Case Study of the Coffee Market

Figure 5.18: A Gourmet Cup of Coffee [8]​


Whether Cup of Joe or Gourmet’s Café, Coffee’s Price is Soaring [3]

“From a cappuccino grande at Starbucks to a plain cup of black no-sugar at a street vendor’s cart, from a pound of Swiss water-processed decaf beans at Zabar’s to a can of ground Folgers at the grocery store, the price of coffee is going up."

                 -David M. Halbfinger for The New York Times, May 13, 1997

Read the full article here and answer the questions below. 

Question 5.42

Question 5.42

Use the concepts of supply and demand to explain what is happening in the case above – and why – in the coffee market. Is it demand, supply, or both changing in this case?

Hover here to see the hint for Question 5.42.
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Question 5.43

Question 5.43

Use the three sections at the end of the article to find examples of elastic and inelastic demand.

Hover here to see the hint for Question 5.43.
Click here to see the answer to Question 5.43.

5.11 A Subsidy of a Specific Good

The flip side of governments imposing and collecting taxes is that sometimes governments pay subsidies. Governments subsidize the production of a wide variety of goods for a wide variety of reasons. The subsidies may be direct in the sense that they are direct payments to the producers. A common example is government payments to farmers in response to specific decisions made by those farmers to produce less of a specific good. At other times, governments subsidize indirectly through the provision of infrastructure, like better roads and easier air transportation, to attract new business into an area.

Graphing Question 5.11

Our most common examples in the U.S. are the subsidies paid to agriculture. While the largest recipients of government subsidies are growers of corn, wheat, cotton, and rice, the list is really much longer – including soybeans, peanuts, honey, sugar, wool, barley, oats, sorghum, milk and other dairy products, and even mohair and tobacco. There may be good reasons for some of the subsidies. We will explore those in greater detail later. However, we can certainly evaluate the effects of subsidies with what we know so far. 

Indicate, in Figure 5.19, the outcome of a direct cash payment to producers in a market based on how many goods or services are produced. What is the effect on prices?

Figure 5.19: The Market for Corn​

Like the impact of a tax, the impact of a subsidy depends on elasticities. If demand is elastic, then the impact of a subsidy will be much greater than if demand were inelastic; i.e., the subsidy will result in a greater change in quantity demanded. This should make sense – the lower price results in a larger change in quantity demanded when consumers are very sensitive to price changes than when they are not.

Graphing Question 5.12

5.12 Summary

  • Elasticity is a measure of the sensitivity of changes in one variable to changes in another. 
  • The price elasticity of demand measures how sensitive the quantity demanded is to changes in the price level of a good. It is the percentage change in the quantity demanded divided by the percentage change in the price of the good. 
  • If elasticity of demand is greater than one (absolute value), then demand is elastic. If it is less than one, it is inelastic.
  • If demand is inelastic, an increase in price will increase the total revenue received by the business, and a decrease in price will reduce total revenue. If demand is elastic, an increase in price will decrease the total revenue received by the business, and a decrease in price will increase total revenue.
  • Whether or not buyers view a good as a necessity, the portion of their income they spend on a good, the number of substitutes there are for the good, and how much time buyers have to adjust to price changes all influence the price elasticity of demand.
  • Demand can be perfectly elastic and perfectly inelastic, but those are exceptions and should be viewed as such.
  • The price elasticity of supply is the percentage change in the quantity supplied divided by the percentage change in the price of the good.
  • Governments sometimes establish price ceilings and price floors. Price ceilings can result in shortages; price floors can cause surpluses. Both create inefficient outcomes in markets.
  • Taxes on goods will affect the equilibrium price and quantity. The effects of the tax on price and quantity depend upon the size of the tax and the relative elasticities of demand and supply.
  • Subsidies of goods and services will decrease the equilibrium price and increase the equilibrium quantity. 

5.13 Key Concepts

  • Price elasticity of demand
  • Price elasticity of supply
  • Elastic demand
  • Inelastic demand
  • Income elasticity of demand
  • Price ceilings
  • Price floors
  • Taxes and tariffs
  • Subsidies

5.14 Glossary

Elastic: Demand is elastic when the percentage change in the quantity demanded is greater than the percentage change in the price of the good or service. The price elasticity of demand is greater than one.
Income elasticity of demand: The percentage change in quantity demanded of a good or service divided by the percentage change in income.
Inelastic: Demand is inelastic when the percentage change in the quantity demanded is less than the percentage change in the price of the good or service. The price elasticity of demand is less than one.
Minimum wage: A legal minimum for wages (the price of one hour of labor) for most categories of workers.
Necessity: A good or service that is viewed by consumers as a high priority. Consumers tend to be less sensitive to price changes of goods that are assumed to be necessities.
Price ceiling: The legal maximum price for which a good or service can be sold. Examples include laws limiting apartment rents in some cities.
Price elasticity of demand: The percentage change in quantity demanded of a good or service divided by the percentage change in price.
Price elasticity of supply: The percentage change in quantity supplied of a good or service divided by the percentage change in price.
Price floor: The legal minimum price at which a good or service can be sold. An example is the federal minimum wage, currently $7.25 per hour.
Rent control: A policy which sets a legal maximum rent that can be charged for some apartments in some major cities.
Subsidies: Payments from governments to producers or consumers of specific goods and services.
Substitutes: Goods or services that consumers consider as serving similar purposes.
Taxes: Mandatory payments to governments from consumers and producers.





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Answer Key

Answer to Question 5.01

The number of substitutes for the good.
Your interpretation of how necessary the good is.
The percentage of your income spent on the good.
The length of time you have to adjust your purchases.

Click here to return to Question 5.01.













Answer to Question 5.03

Similar reasoning is appropriate here. Demand for a product, in general, will always tend to be less elastic than the demand for a specific brand of the same product. There are more substitutes for a specific brand, and thus the specific brand demand should be more elastic, so the demand for a degree at a specific institution will be more elastic than the demand for a degree.

Click here to return to Question 5.03.













Answer to Question 5.05

Think of this as an approximation. Revenues rise by 10 percent due to the increase in price and fall by only 5 percent due to the lost sales, that is, the lower quantity. Thus, overall revenues must increase. (And, in fact, if we do the exact calculations, the initial revenue is 100 x $200 or $20,000. If price increases by 10 percent, the new price is $220, and if quantity falls by 5 percent, the new quantity is 95. Therefore, the new revenue is $20,900, an increase of $900 over the initial revenue.

Click here to return to Question 5.05.












Answer to Question 5.06

Think of this as an approximation. Revenues rise by 10 percent due to the increase in price and fall by 20 percent due to the lost sales. Thus, total revenues decline. If we do the calculations, one can see that revenues do actually decrease from $20,000 to $17,600. The initial revenues (100 x $200 ) are $20,000. The new lower revenues (80 x $220) are $17,600.

Click here to return to Question 5.06.













Answer to Question 5.13

They could have found other forms of transportation, or they could have moved closer to their place of employment, or they could have started walking. The longer the period of time, the more likely it is that consumers will find substitutes.

Click here to return to Question 5.13.














Answer to Question 5.16

One possible reason is that there tend to be more things to do in most parts of the country in the summer than in the winter, so movies in the summer have more substitutes than in the winter.

Click here to return to Question 5.16.














Answer to Question 5.17

If the percentage change in quantity demanded is greater than the percentage change in price, the ratio of the percentage change in quantity demanded to the percentage change in price is greater than one. The quantity demanded is very sensitive to changes in price, and we describe demand as being elastic.

If the percentage change in quantity demanded is less than the percentage change in price, the ratio of the percentage change in quantity demanded to the percentage change in price is less than one. The quantity demanded is less sensitive to changes in price, and we describe demand as being inelastic.

Click here to return to Question 5.17.​











Answer to Question 5.21

A drought will decrease supply, increasing the price of agricultural products. If agricultural products have an inelastic demand, then the increase in price will lead to an increase in farmers’ incomes.

Click here to return to Question 5.21.














Answer to Question 5.22

If income elasticity is 0.8, then the good is a normal good, meaning that as income increases, so does demand for the good, and if income decreases, demand also falls. If we enter a recession, consumer incomes will fall; therefore, the demand for this good will also fall.

Click here to return to Question 5.22.













Answer to Question 5.23

It is a lot easier for a producer to make more ice cream than it is to mine more diamonds, so the producer of ice cream will be more sensitive to price changes – supply will be more elastic.

Click here to return to Question 5.23.













Answer to Question 5.25

A price ceiling of $20 is shown in a market where the equilibrium price is about $15. The quantity supplied is about 9,500 and the quantity demanded is about 5,000. The resulting surplus of about 4,500 will drive prices down to the equilibrium price. Thus, the price ceiling has no effect on the market. It is not a meaningful price ceiling. In order to have meaning or to be effective, it has to be below the equilibrium price.

Click here to return to Question 5.25.












Answer to Question 5.31

If we are concerned with milk producers’ incomes, then perhaps it is fair to raise the price of milk. If we are concerned with consumers, then a price floor is not fair. A price floor will not result in an efficient outcome because the price does not clear the market. 

Click here to return to Question 5.31.













Answer to Question 5.32

The supply of labor is the number of workers who are willing to work at each wage. More workers would be willing to work in an industry as the wage increases. Businesses demand workers to produce their goods and services. At high wages, businesses would tend to use less labor, and at lower wages, businesses would increase the amount of labor they want to hire.

Click here to return to Question 5.32.












Answer to Question 5.33

Raising the minimum wage will increase the number of workers willing to work and decrease the number of workers businesses want to hire. It will increase the amount of unemployment. However, it will also increase the incomes of those able to find jobs at the minimum wage.

Click here to return Question 5.33.













Answer to Question 5.34

The supply curve shows that the quantity supplied increases from the equilibrium quantity. The demand curve shows that the quantity demanded decreases from the equilibrium quantity. A surplus of workers will be created. The surplus is the unemployment. Those working (the quantity demanded) will be working at a higher wage.

Click here to return Question 5.34.







Answer to Question 5.35

This is a graphical answer that is the same as what is in the text (Figure 5.15 and Figure 5.16). See below. 

Figure 5.15​


Figure 5.16​


Click here to return to Question 5.35.




Answer to Question 5.36

Regardless of which side of the market is assessed, taxes are shared by both consumers and producers. The more price sensitive one side of the market is, the lower proportion of the tax that side will bear. For example, if consumers are very responsive to price changes (relative to producers), then they will bear less of the tax than producers will. In the case of cigarettes, teenagers probably have a more elastic demand than adults since they may not be as addicted. 

Click here to return to Question 5.36.












Answer to Question 5.42

Demand is increasing because of the increased tastes for good coffee. But supply also seems to be decreasing because of weather issues with the coffee crop and because businesses expect reduced future supply. 

It also seems as though there are fewer suppliers as “low coffee prices in 1995 and 1996 drove some growers out of the business.”  So it is a combination of changes in demand and supply that is causing the price increases in the coffee industry.

Click here to return to Question 5.42.












Answer to Question 5.43

Paragraph I. People like Ms. Fenton will switch. The last sentence in this section says that prices tripled and quantity demanded fell by ten percent, indicating that demand is inelastic.

Paragraph II. The owners of the carts must believe demand is elastic because they are unwilling to raise prices. Or perhaps they don’t understand elasticity – or perhaps they are very generous people, not interested in profits. Neither of these is likely in most cases.

Paragraph III. Ms. McLemore has what sounds like perfectly inelastic demand for coffee as she “doesn’t look at the price.”

Click here to return to Question 5.43.










Image Credits

[1] Image courtesy of Padraic under CC BY-SA 2.0.

[2] Image courtesy of Mike Licht under CC BY 2.0.  

[3] Image courtesy of aroblesgalit in the Public Domain.

[4] Image courtesy of Mr Hyde in the Public Domain.

[5] Image courtesy of Keith Weller in the Public Domain.

[6] Image courtesy of Alegsa under CC BY-SA 3.0

[7] Image courtesy of Officer under CC BY-SA 3.0

[8] Image courtesy of Hrovatic Tilen in the Public Domain.

The quantity demanded is sensitive to changes in prices. Specifically, demand is elastic if the percentage change in quantity demanded divided by the percentage change in price is greater than one.
The quantity demanded is not as sensitive to changes in prices. Specifically, demand is inelastic if the percentage change in quantity demanded divided by the percentage change in price is less than one.
Make sure you focus on how sensitive you are to price.
Again, think about how the number of substitutes affects responsiveness.
The percent change in revenue is approximately equal to the sum of the percent change in price and the percent change in quantity.
Which is going to have the greater impact on revenue?
How could consumers respond over a period as long as two years?
Think of substitutes.
Think about what happens when demand is more elastic compared to when it isn't and how changes in price will affect demand.
The percentage change in quantity supplied divided by the percentage change in the price of the good or service.
The percentage change in quantity supplied is greater than the percentage change in price.
The percentage change in quantity supplied is less than the percentage change in price.
The percentage change in quantity demanded divided by the percentage change in income.
What happens to price in a drought?
What happens to incomes in a recession?
Think of how easy it is for producers to change production.
A legal maximum price. An effective price ceiling is a legal maximum price that is below the equilibrium price.
Compare the quantities associated with demand and supply.
A legal minimum price. An effective price floor is a legal minimum price that is above the equilibrium.
Who benefits from a price floor?
Compare the quantities associated with demand and supply when the price is set at the price ceiling.
Think about what raising a minimum wage would mean to the recipients. Also think about its possible effect on employment levels.
Assume supply and demand for labor follow the same model as that for other goods and services.
Think of the tax as an increase in the cost of doing business for producers.
Do producers bear the full cost? How would price sensitivity affect producers and consumers with respect to how much of a tax they are willing to bear?
Think about the factors that would lead to price increases.
What do these examples say about how responsive these people are, or how responsive they think their customers are?