1. Understanding Economics 6th edition by Mark Lovewell Chapter 3 Competitive Dynamics and Government Copyright © 2012 by McGraw-Hill Ryerson Limited. All rights reserved.

2. Learning Objectives After this chapter, you will be able to: 1. comprehend price elasticity of demand, its relation to other demand elasticities, and its impact on sellers’ revenues 2. understand the price elasticity of supply and the links between production periods and supply 3. explain how governments use price controls to override the “invisible hand” of competition 4. understand a bit more about how governments tax and spend Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

3. Elastic and Inelastic Demand (a) Price elasticity of demand shows how responsive consumers are to price changes. elastic demand means % change in quantity demanded is more than % change in price inelastic demand means % change in quantity demanded is less than % change in price unit-elastic demand means % change in quantity demand equals % change in price Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

4. Elastic and Inelastic Demand (b) Figure 3.1 Page 61 Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Elastic Demand Curve for Ice Cream Cones 05001000 0.40 0.80 1.20 1.60 2.00 2.40 20% 50% 20% 10% D1 D2 Quantity Demanded (cones per winter month) Price ($ per cone) Inelastic Demand Curve for Ice cream Cones 0.40 0.80 1.20 1.60 2.00 2.40 05001000 Quantity Demanded (cones per summer month) Price ($ per cone) 1800 2000

5. Calculating Price Elasticity of Demand A numerical value for price elasticity of demand (ed) is found by taking the ratio of the changes in quantity demanded and in price, each divided by its average value. In mathematical terms: ed = ΔQd ÷ average Qd Δprice ÷ average price Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

6. Perfectly Elastic and Perfectly Inelastic Demand (a) Perfectly elastic demand means a constant price and a horizontal demand curve. Perfectly inelastic demand means a constant quantity demanded and a vertical demand curve. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

7. Perfectly Elastic and Perfectly Inelastic Demand (b) Figure 3.2 Page 62 Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Perfectly Elastic Demand Curve for Soybeans 0 1.60 D3 Quantity Demanded (tonnes) Price ($ per tonnes) Perfectly Inelastic Demand Curve for Insulin 01000 Quantity Demanded (litres) Price ($ per tonnes) D4

8. Total Revenue and the Price Elasticity of Demand (a) A price change causes total revenue to change in the opposite direction when demand is elastic. A price change causes total revenue to change in the same direction when demand is inelastic. A price change does not affect total revenue when demand is unit-elastic. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

9. Revenue Changes with Elastic Demand Figure 3.3 Page 63 Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Demand Curve for DVDs 1 2 3 4 5 05001000 Quantity Demanded (DVDs rented each day) Price ($ to rent a DVD) 1500 A BC D

10. Revenue Changes with Inelastic Demand Figure 3.4 Page 64 Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Demand Curve for Amusement Park Rides 1 2 3 4 5 020006000 10 000 E FG D 4000 8000 Quantity Demanded (riders each day) Price ($ per ride)

11. Question: Should a company raise or lower its price to make more money? Figure 3.1 Page 61 Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Elastic Demand Curve for Ice Cream Cones 05001000 0.40 0.80 1.20 1.60 2.00 2.40 20% 50% 20% 10% D1 D2 Quantity Demanded (cones per winter month) Price ($ per cone) Inelastic Demand Curve for Ice cream Cones 0.40 0.80 1.20 1.60 2.00 2.40 05001000 Quantity Demanded (cones per summer month) Price ($ per cone) 1800 2000

12. Total Revenue and the Price Elasticity of Demand (b) Figure 3.5 Page 64 Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Demand Elasticity and Changes in Total Revenue Elastic Demand Inelastic Demand Unit-Elastic Demand Price Change up down up down up down Change in Total Revenue down up down unchanged

13. Determinants of the Price Elasticity of Demand There are four determinants: portion of consumer incomes (products with smaller portions more inelastic) access to substitutes (products with more substitutes more elastic) necessities versus luxuries (more inelastic for necessities and more elastic for luxuries) time (more elastic with the passage of time) Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

14. Income Elasticity Income elasticity (ei) is the responsiveness of a product’s quantity demanded to changes in consumer income. In mathematical terms: ei = ΔQd ÷ average Qd ΔI ÷ average I Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

15. Cross-Price Elasticity Cross-price elasticity (ei) is the responsiveness of the quantity demanded of one product (x) to a change in price of another (y). In mathematical terms: exy = ΔQd ÷ average Qd ΔPy ÷ average Py Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

16. Elastic and Inelastic Supply Price elasticity of supply measures the responsiveness of quantity supplied to price changes. Elastic supply means % change in quantity supplied is more than % change in price. Inelastic supply means % change in quantity supplied is less than % change in price. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

17. Elastic and Inelastic Supply Figure 3.7, Page 70 Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Elastic Supply Curve for Tomatoes 0100 000120000 1 2 3 4 S1 Quantity Supplied (kilograms per year) Price ($ per kilogram) 0 Inelastic Supply Curve For Tomatoes 100 000120 000 Quantity Supplied (kilograms per year) Price ($ per kilogram) 1 2 3 4 S2 50% 100%20%

18. Perfectly Elastic and Perfectly Inelastic Supply Perfectly elastic supply means a constant price and a horizontal supply curve. Perfectly inelastic supply means a constant quantity supplied and a vertical supply curve. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

19. Time and the Price Elasticity of Supply (a) Price elasticity of supply changes over three production periods: Supply is perfectly inelastic in the immediate run. Supply is either elastic or inelastic in the short run. Supply is perfectly elastic for a constant-cost industry and very elastic for an increasing-cost industry in the long run. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

20. Time and the Price Elasticity of Supply (b) Figure 3.8, Page 71 (continued in part (e)) Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Immediate-Run Supply Elasticity for Strawberries 0 S1 Quantity Supplied (kilograms per month) Price ($ per kilogram) S2 750 0000 Short-Run Supply Elasticity For Strawberries 11 Quantity Supplied (millions of kilograms per year) Price ($ per kilograms) 2.50 2.00 9

21. Calculating Price Elasticity of Supply A numerical value for price elasticity of supply (es) is found by taking the ratio of the changes in quantity supplied and in price, each divided by its average value. In mathematical terms: es = ΔQs ÷ average Qs Δprice ÷ average price Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

22. Price Controls A price floor is a minimum price set above the equilibrium price. It results in a surplus in the market. A price ceiling is a maximum price set below the equilibrium price. It results in a shortage in the market. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

23. Agricultural Price Supports Price supports for agricultural goods are an example of a price floor. They help overcome unstable agricultural prices. Farmers win from these supports. Consumers and taxpayers lose from these supports. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

24. Rent Controls Rent controls are an example of a price ceiling. They keep down prices of controlled rental accommodation. Some (especially middle-class) tenants win from these controls. Other (especially poorer) tenants lose from these controls. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

25. Effects of Rent Controls Figure 3.15, page 80 Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. 0 Quantity (units rented per month) Market Demand and Supply Curves for Units Price ($ per unit) 300 500 700 S D Market Demand and Supply Schedules for Units $700 500 300 2000 1700 2300 2000 2500 1500 (units rented per month) Price ($ rent per month) A price ceiling creates a shortage. 1500 2000 2500 shortage 2300 Quantity Supplied (S) Quantity Demanded (D)

26. For the Public Good (OLC) Besides intervening in private markets, Canadian governments have an independent role. Government programs include payments to adults with children, retirement funds for the elderly, unemployment insurance, welfare, higher education subsidies, free health care and schooling, and subsidized public housing. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

27. For the Public Good (OLC) Federal Spending The main federal spending programs are: transfer payments to seniors (the Seniors Benefit) tax credits to low-income parents (the Child Tax Credit) transfer payments to the unemployed (Employment Insurance) pensions (the Quebec and Canada Pension Plans) Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

28. For the Public Good (OLC) Provincial and Territorial Spending The responsibilities of provincial and territorial governments include: health care subsidies for post-secondary education welfare services The federal government pays a portion of these costs through the Canada Health and Social Transfer (CHST). Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

29. For the Public Good (OLC) Government Expenditures Figure A Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Goods and services Transfers to Persons Businesses Nonresidents Provinces and local Debt charges 63.9 87.9 4.5 4.8 65.1 26.1 253.1 Federal (2009) ($ billions) Goods and services Transfers to Persons Businesses Governments Debt charges 214.1 43.1 11.1 52.5 28.3 349.2 Provincial (2009) ($ billions) Goods and services Transfers to Persons Businesses Provinces Debt Charges 109.1 4.0 2.2 0.1 3.5 118.9 Local (2009) ($ billions)

30. For the Public Good (OLC) Taxation (a) Canadian governments use five main types of taxation: Personal income taxes are levied by both federal and provincial governments, and are based on four marginal federal tax rates (15%, 22%, 26%, and 29%). Sales taxes are levied by both federal and provincial governments, and are charged as a percentage of price on a wide range of products. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

31. For the Public Good (OLC) Taxation (b) Excise taxes are levied by both federal and provincial governments, and are usually charged as a dollar amount per unit of quantity on particular products. Property taxes are charged by local governments on buildings and land. Corporate income taxes are paid by corporations to both federal and provincial governments as a percentage of annual profits. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

32. For the Public Good (OLC) Tax Revenues for All Levels of Government (2009) Figure B Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved. Personal income taxes Sales and excise taxes Property taxes Corporate income taxes Miscellaneous taxes Percent of Gross Domestic Product 11.5 8.7 3.2 2.5 4.6 30.5 Percent of Total Taxes 37.6 28.4 10.5 8.2 15.0 100.0

33. For the Public Good (OLC) Taxes and the Canadian Economy Figure C Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

34. For the Public Good (OLC) Debates over Government’s Role (a) Taxes have increased significantly as a proportion of the total Canadian economy over the past few decades. Critics argue that taxes and some spending programs reduce productive activity. Critics also contend that many government programs are inequitable, and hampered by administrative problems. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.

35. For the Public Good (OLC) Debates Over Government’s Role (b) Supporters of government admit that public spending and taxation are not as effective as they could be. But they argue that these problems need to be seen in perspective, given that private markets are also subject to a variety of flaws. Copyright © 2012 by McGraw- Hill Ryerson Limited. All rights reserved.