Application: The Costs of Taxation PDF

APPLICATION: THE COSTS OF TAXATION Chapter 8 Copyright © 2024 Cengage Learning Canada, Inc. 8-1  APPLICATION: THE COSTS OF TAXATION  To understand fully how taxes affect economic well-being, we must compare the reduced welfare of buyers and s...

APPLICATION: THE COSTS OF TAXATION Chapter 8 Copyright © 2024 Cengage Learning Canada, Inc. 8-1  APPLICATION: THE COSTS OF TAXATION  To understand fully how taxes affect economic well-being, we must compare the reduced welfare of buyers and sellers to the amount of revenue the government raises, and the uses to which the tax revenue is put.  The tools of consumer and producer surplus allow us to make this comparison.  The analysis will show that the cost of taxes to 8 buyers and sellers exceeds the revenue raised by Copyright © 2024 Cengage Learning Canada, Inc. 8-2 THE DEADWEIGHT LOSS OF TAXATION  When a tax is levied on buyers, the demand curve shifts downward by the size of the tax.  When it is levied on sellers, the supply curve shifts upward by that amount.  In either case, the tax raises the price paid by buyers and reduces the price received by sellers (i.e., buyers and sellers share the burden of the tax).  How the tax burden is distributed between producers and consumers depends not on how the tax is levied but on the elasticities of supply and demand. 8-1 Copyright © 2024 Cengage Learning Canada, Inc. 8-3  FIGURE 8.1 The Effects of a Tax 8-1 Copyright © 2024 Cengage Learning Canada, Inc. 8-4  A tax on a good places a wedge between the price that buyers pay and the price that sellers receive. The quantity of the good sold falls. Copyright © 2024 Cengage Learning Canada, Inc. 8-5 THE DEADWEIGHT LOSS OF TAXATION HOW A TAX AFFECTS MARKET PARTICIPANTS  The tools of welfare economics to measure the gains and losses from a tax on a good assesses how this tax affects buyers, sellers, and the government.  The benefit received by buyers in a market is measured by consumer surplus.  The benefit received by sellers in a market is measured by producer surplus.  Deadweight loss: the fall in total surplus that results from a market distortion, such as a tax 8- Copyright © 2024 Cengage Learning Canada, Inc. 8-6 1a  FIGURE 8.2 Tax Revenue 8- Copyright © 2024 Cengage Learning Canada, Inc. 8-7 1a  The tax revenue that the government collects equals T × Q, the size of the tax T times the quantity sold Q.  Thus, tax revenue equals the area of the rectangle between the supply and demand curves. Copyright © 2024 Cengage Learning Canada, Inc. 8-8  FIGURE 8.3 How a Tax Affects Welfare 8- Copyright © 2024 Cengage Learning Canada, Inc. 8-9 1a  A tax on a good reduces consumer surplus (by the area B + C) and pro­ducer surplus (by the area D + E).  Because the fall in producer and con­sumer surplus exceeds tax revenue (area B + D), the tax is said to impose a deadweight loss (area C + E). Copyright © 2024 Cengage Learning Canada, Inc. 8-10 THE DEADWEIGHT LOSS OF TAXATION DEADWEIGHT LOSSES AND THE GAINS FROM TRADE  Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade. 8- Copyright © 2024 Cengage Learning Canada, Inc. 8-11 1b  FIGURE 8.4 The Deadweight Loss 8- Copyright © 2024 Cengage Learning Canada, Inc. 8-12 1b  When the government imposes a tax on a good, the quantity sold falls from Q1 to Q2.  As a result, some of the potential gains from trade among buyers and sellers do not get real­- ized.  These lost gains from trade create the dead­- weight loss. Copyright © 2024 Cengage Learning Canada, Inc. 8-13  Active Learning The market for airplane Analysis of a Tax tickets P $400 A. Compute CS, PS, 350 and total surplus 300 S without 250 a tax. 200 B. If $100 tax per 150 ticket, 100 D compute CS, PS, 50 tax revenue, total 0 Q surplus, and DWL. 0 25 50 75 100 125 8-1 Copyright © 2024 Cengage Learning Canada, Inc. 8-14  Active The market for airplane tickets Learning $ P 400 Answers to A. CS = ½ × $200 ×100 350 = $10 000 300 S PS = ½ × $200 × 250 100 P = 200 = $10 000 150 Total surplus = D 100 $10 000 + $10 000 50 = $20 000 0 Q 0 25 50 75 100 125 8-1 Copyright © 2024 Cengage Learning Canada, Inc. 8-15  Active The market for airplane tickets Learning P A $100 tax on $ 400 airplane tickets Answers to B. CS = ½ × $150 350 × 75 300 = $5625 S PS = $5625 PB = 250 200 Tax revenue = $100 × 75 PS = 150 = $7500 100 D Total surplus 50 = $18 750 0 Q DWL = 0 25 50 75 100 125 8-1 $1250 Copyright © 2024 Cengage Learning Canada, Inc. 8-16  THE DETERMINANTS OF THE DEADWEIGHT LOSS  What determines whether the deadweight loss from a tax is large or small?  The answer is the price elasticities of supply and demand, which measure how much the quantity supplied and quantity demanded respond to changes in the price.  The deadweight loss of a tax is greater the greater is the elasticity of the tax base with respect to the tax.  Elasticity of the tax base: the sensitivity of the tax base to changes in the tax rate. 8-2 Copyright © 2024 Cengage Learning Canada, Inc. 8-17  FIGURE 8.5 Tax Distortions and Elasticities 8-2 Copyright © 2024 Cengage Learning Canada, Inc. 8-18  In panels (a) and (b), the demand curve and the size of the tax are the same, but the price elasticity of supply is different.  Notice that the more elastic the supply curve, the larger the deadweight loss of the tax. Copyright © 2024 Cengage Learning Canada, Inc. 8-19  FIGURE 8.5 Tax Distortions and Elasticities (cont’d) 8-2 Copyright © 2024 Cengage Learning Canada, Inc. 8-20  In panels (c) and (d), the supply curve and the size of the tax are the same, but the price elasticity of demand is different.  Notice that the more elastic the demand curve, the larger the deadweight loss of the tax. Copyright © 2024 Cengage Learning Canada, Inc. 8-21  DEADWEIGHT LOSS AND TAX REVENUE AS TAXES VARY  What happens to the deadweight loss and tax revenue when the size of a tax changes? 8-3 Copyright © 2024 Cengage Learning Canada, Inc. 8-22  FIGURE 8.6 Deadweight Loss and Tax Revenue from Three Taxes of Different Sizes 8-3 Copyright © 2024 Cengage Learning Canada, Inc. 8-23  The deadweight loss is the reduction in total surplus due to the tax.  Tax revenue is the amount of the tax times the amount of the good sold. In panel (a), a small tax has a small deadweight loss and raises a small amount of revenue.  In panel (b), a somewhat larger tax has a larger deadweight loss and raises a larger amount of revenue.  In panel (c), a very large tax has a very large deadweight loss, but because it has reduced the size of the market so much, the tax raises only a small amount of revenue. Copyright © 2024 Cengage Learning Canada, Inc. 8-24  FIGURE 8.6 Deadweight Loss and Tax Revenue from Three Taxes of Different Sizes (cont’d) 8-3 Copyright © 2024 Cengage Learning Canada, Inc. 8-25  Panels (d) and (e) summarize these conclusions.  Panel (d) shows that as the size of the tax grows larger, the deadweight loss grows larger.  Panel (e) shows that tax revenue first rises then falls.  This relationship is sometimes called the Laffer curve.  The curve in panel (e) of Figure 8.6 is sometimes called the Laffer curve, after economist Arthur Laffer.  One day in 1974, Laffer sat in a Washington restaurant with some prominent journalists and politicians.  Famously, he took out a napkin and drew a figure on it to show how tax rates affect tax revenue.  It looked much like panel (e) of our Figure 8.6. Laffer then suggested that the United States was on the downward-sloping side (the “wrong side”) of this curve.  Tax rates were so high, he argued, that reducing them would actually raise tax revenue. Copyright © 2024 Cengage Learning Canada, Inc. 8-26  FIGURE 8.7 The Effect of a Tax Increase 8-3 Copyright © 2024 Cengage Learning Canada, Inc. 8-27  At the initial tax of T1 the deadweight loss is A and revenue is C + E.  At the higher tax rate T2, the deadweight loss is A + B + C + D and revenue is F + E + G.  The change in the deadweight loss from increasing the tax is ∆DWL = A + B + C + D – A = B + C + D, and the change in revenue is ∆R = F + E + G – (E + C) = F + G – C Copyright © 2024 Cengage Learning Canada, Inc. 8-28  THE COST OF TAXES AND THE SIZE OF GOVERNMENT  How big should the government be?  The larger the deadweight loss of taxation, the larger the cost of any government program.  If taxation entails large deadweight losses, then these losses are an argument for a leaner government that does less and taxes less.  But if taxes impose small deadweight losses, then government programs are less costly than they otherwise might be. 8-4 Copyright © 2024 Cengage Learning Canada, Inc. 8-29  APPENDIX THE MATHEMATICS OF DEADWEIGHT LOSS  Figure 8.3 shows how the various areas between the supply and demand curves can be used to determine how taxes affect welfare.  From the appendix to Chapter 7: 8A Copyright © 2024 Cengage Learning Canada, Inc. 8-30  APPENDIX THE MATHEMATICS OF DEADWEIGHT LOSS  Example (from the appendix to Chapter 6):  This is the amount by which the losses of the buyers and sellers of the good due to the tax exceed the revenue raised by the tax. 8A Copyright © 2024 Cengage Learning Canada, Inc. 8-31  FIGURE 8A.1 Deadweight Loss of a Tax 8-4 Copyright © 2024 Cengage Learning Canada, Inc. 8-32  This figure illustrates the revenue raised and the deadweight loss associated with a tax in the case of a demand curve QD = 56 – 4PB and supply curve QS = –4 + 2PS.  The deadweight loss of the tax is given by the area of the identified triangle ($1.50) and the revenue raised is given by the area of the rectangle. Copyright © 2024 Cengage Learning Canada, Inc. 8-33 THE END Copyright © 2024 Cengage Learning Canada, Inc. 8-34 CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS Chapter 7 Copyright © 2024 Cengage Learning Canada, Inc. 7-35  CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS  In this chapter, the benefits that buyers and sellers receive from taking part in a market are examined.  We then examine how society can make these benefits as large as possible.  This leads to the profound conclusion that the equilibrium of supply and demand in a market maximizes the total benefits received by 7 buyers and sellers. Copyright © 2024 Cengage Learning Canada, Inc. 7-36  CONSUMERS, PRODUCERS, AND THE EFFICIENCY OF MARKETS  Welfare economics is the study of how the allocation of resources affects economic well- being. 7 Copyright © 2024 Cengage Learning Canada, Inc. 7-37  We begin by examining the benefits buyers and sellers receive from engaging in market transactions in any perfectly competitive market  We then examine how society can make these benefits are large as possible Copyright © 2024 Cengage Learning Canada, Inc. 7-38  This analysis leads to a profound conclusion  In any market, the equilibrium of supply and demand maximizes the total benefits received by buyers and sellers combined Copyright © 2024 Cengage Learning Canada, Inc. 7-39  CONSUMER SURPLUS  The study of welfare economics begins by looking at the benefits buyers receive from participating in a market.  Willingness to pay is the maximum amount that a buyer will pay for a good. 7-1 Copyright © 2024 Cengage Learning Canada, Inc. 7-40  CONSUMER SURPLUS WILLINGNESS TO PAY  What benefit does John receive from buying the Elvis Presley album?  Consumer surplus is a buyer’s willingness to pay minus the amount the buyer actually pays. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-41 1a  TABLE 7.1 Four Possible Buyers’ Willingness to Pay 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-42 1b  Four Elvis fans show up for your auction: Taylor, Carrie, Rihanna, and Gaga.  Each of them would like to own the album, but there is a limit to the amount that each is willing to pay for it. Table 7.1 shows the maximum price that each of the four possible buyers would pay.  Each buyer’s maximum is called her willingness to pay.  What benefit does Taylor receive from buying the Elvis Presley album? Copyright © 2024 Cengage Learning Canada, Inc. 7-43  In a sense, Taylor has found a real bargain: She is willing to pay $100 for the album but pays only $80 for it. We say that Taylor receives consumer surplus of $20.  Now consider a somewhat different example. Suppose you had two identical Elvis Presley albums to sell. Again, you auction them off to the four possible buyers.  To keep things simple, we assume that both albums are to be sold for the same price and that no buyer is interested in buying more than one album. Therefore, the price rises until two buyers are left. Copyright © 2024 Cengage Learning Canada, Inc. 7-44  CONSUMER SURPLUS USING THE THE DEMAND CURVE TO MEASURE CONSUMER SURPLUS  Consumer surplus is closely related to the demand curve for a product.  Because the demand curve reflects buyers’ willingness to pay, it can also be used to measure consumer surplus. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-45 1b  FIGURE 7.1 The Demand Schedule and the Demand Curve 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-46 1b  The table shows the demand schedule for the buyers in Table 7.1.  The graph shows the corresponding demand curve.  Note that the height of the demand curve reflects buyers’ willingness to pay Copyright © 2024 Cengage Learning Canada, Inc. 7-47  FIGURE 7.2 Measuring Consumer Surplus with the Demand Curve 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-48 1b  In panel (a), the price of the good is $80, and the consumer surplus is $20.  In panel (b), the price of the good is $70, and the consumer surplus is $40. Copyright © 2024 Cengage Learning Canada, Inc. 7-49  CONSUMER SURPLUS USING THE THE DEMAND CURVE TO MEASURE CONSUMER SURPLUS (CONT’D)  The area below the demand curve and above the price measures the consumer surplus in a market.  The difference between this willingness to pay and the market price is each buyer’s consumer surplus.  Thus, the total area below the demand curve and above the price is the sum of the consumer surplus of all buyers in the market for a good or service. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-50 1b  CONSUMER SURPLUS HOW A LOWER PRICE RAISES CONSUMER SURPLUS  How much does buyers’ well-being rise in response to a lower price?  The concept of consumer surplus helps answer this question. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-51 1c  FIGURE 7.3 How the Price Affects Consumer Surplus 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-52 1c  In panel (a), the price is P1, the quantity demanded is Q1, and consumer surplus equals the area of the triangle ABC.  When the price falls from P1 to P2, as in panel (b), the quantity demanded rises from Q1 to Q2, and the consumer surplus rises to the area of the triangle ADF.  The increase in consumer surplus (area BCFD) occurs in part because existing consumers now pay less (area BCED) and in part because new consumers enter the market at the lower price (area CEF). Copyright © 2024 Cengage Learning Canada, Inc. 7-53  CONSUMER SURPLUS WHAT DOES CONSUMER SURPLUS  Consumer surplus MEASURE? measures the benefit that buyers receive from a good as the buyers themselves perceive it.  Thus, consumer surplus is a good measure of economic well-being (if policymakers want to respect the preferences of buyers).  In some circumstances, policymakers might choose not 7- to care about consumer surplus Copyright © 2024 Cengage because Learning Canada, Inc. they do not7-54 1d  PRODUCER SURPLUS  Let’s consider the benefits that sellers receive from participating in a market. 7-2 Copyright © 2024 Cengage Learning Canada, Inc. 7-55  PRODUCER SURPLUS COST AND THE WILLINGNESS TO SELL  Cost is the value of everything a seller must give up to produce a good (i.e., the producers’ opportunity cost).  Producer surplus is the amount a seller is paid for a good minus the seller’s cost. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-56 2a  TABLE 7.2 The Costs of Four Possible Sellers 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-57 2a  Table 7.2 shows each painter’s cost. Because a painter’s cost is the lowest price he would accept for his work, cost is a measure of his willingness to sell his services.  Each painter would be eager to sell his services at a price greater than his cost, and he would refuse to sell his services at a price less than his cost.  At a price exactly equal to his cost, he would be indifferent about selling his services: He would be equally happy getting the job or walking away without incurring the cost. When you take bids from the painters, the price might start off high, but it quickly falls as the painters compete for the job.  Once Andy has bid $600 (or slightly less), he is the sole remaining bidder. He is happy to do the job for this price because his cost is only $500. Vincent, Claude, and Pablo are unwilling to do the job for less than $600.  Note that the job goes to the painter who can do the work at the lowest cost. What benefit does Andy receive from getting the job? Copyright © 2024 Cengage Learning Canada, Inc. 7-58  Because he is willing to do the work for $500 but gets $600 for doing it, we say that he receives producer surplus of $100.  Producer surplus is the amount a seller is paid minus the cost of production. Producer surplus measures the benefit to sellers of participating in a market.  Now consider a somewhat different example. Suppose that you have two identical houses that need painting. Again, you auction off the jobs to the four painters.  To keep things simple, let’s assume that no painter is able to paint both houses and that you will pay the same amount to paint each house.  Therefore, the price falls until two painters are left. In this case, the bidding stops when Andy and Pablo each offer to do the job for a price of $800 (or slightly less). At this price, Andy and Pablo are willing to do the work, and Vincent and Claude are not willing to bid a lower price.  At a price of $800, Andy receives producer surplus of $300, and Pablo receives producer surplus of $200. The total producer surplus in the market is $500. Copyright © 2024 Cengage Learning Canada, Inc. 7-59  PRODUCER SURPLUS USING THE SUPPLY CURVE TO MEASURE PRODUCER  The producer SURPLUS surplus is closely related to the supply curve. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-60 2b  FIGURE 7.4 The Supply Schedule and the Supply Curve 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-61 2b  The table shows the supply schedule for the sellers in Table 7.2. The graph shows the corresponding supply curve. Note that the height of the supply curve reflects sellers’ costs.  The graph in Figure 7.4 shows the supply curve that corresponds to this supply schedule. Note that the height of the supply curve is related to the sellers’ costs.  At any quantity, the price given by the supply curve shows the cost of the marginal seller, the seller who would leave the market first if the price were any lower.  At a quantity of 4 houses, for instance, the supply curve has a height of $900, the cost that Vincent (the marginal seller) incurs to provide his painting services.  At a quantity of 3 houses, the supply curve has a height of $800, the cost that Claude (who is now the marginal seller) incurs. Copyright © 2024 Cengage Learning Canada, Inc. 7-62  FIGURE 7.5 Measuring Producer Surplus with the Supply Curve 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-63 2b  Because the supply curve reflects sellers’ costs, we can use it to measure producer surplus.  Figure 7.5 uses the supply curve to compute producer surplus in our example.  In panel (a), we assume that the price is $600. In this case, the quantity supplied is 1.  Note that the area below the price and above the supply curve equals $100. Copyright © 2024 Cengage Learning Canada, Inc. 7-64  This amount is exactly the producer surplus we computed earlier for Andy.  Panel (b) shows producer surplus at a price of $800.  In this case, the area below the price and above the supply curve equals the total area of the two rectangles.  This area equals $500, the producer surplus we computed earlier for Pablo and Andy when two houses needed painting. Copyright © 2024 Cengage Learning Canada, Inc. 7-65  PRODUCER SURPLUS USING THE SUPPLY CURVE TO MEASURE  PRODUCER The area SURPLUS above the supply (CONT’D) curve and below the price measures the producer surplus in a market.  The logic is straightforward: The height of the supply curve measures sellers’ costs, and the difference between the price and the cost of production is each seller’s producer surplus.  Thus, the total area is the sum of the producer surplus of 7- 2b all sellers. Copyright © 2024 Cengage Learning Canada, Inc. 7-66  PRODUCER SURPLUS HOW A HIGHER PRICE RAISES  PRODUCER It is not surprising SURPLUS to hear that sellers always want to receive a higher price for the goods they sell.  But how much does sellers’ well-being rise in response to a higher price?  The concept of producer surplus offers a precise answer to this question. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-67 2c  FIGURE 7.6 How the Price Affects Producer Surplus 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-68 2c  In panel (a), the price is P1, the quantity supplied is Q1, and producer surplus equals the area of the triangle ABC.  When the price rises from P1 to P2 , as in panel (b), the quantity supplied rises from Q1 to Q2, and the producer surplus rises to the area of the triangle ADF.  The increase in producer surplus (area BCFD) occurs in part because existing producers now receive more (area BCED) and in part because new producers enter the market at the higher price (area CEF). Copyright © 2024 Cengage Learning Canada, Inc. 7-69  MARKET EFFICIENCY  Consumer surplus and producer surplus are the basic tools that economists use to study the welfare of buyers and sellers in a market.  These tools can help us address a fundamental economic question:  Is the allocation of resources determined by free markets in any way desirable? 7-3 Copyright © 2024 Cengage Learning Canada, Inc. 7-70  MARKET EFFICIENCY THE BENEVOLENT SOCIAL PLANNER  The benevolent social planner is an all-knowing, all- powerful, well-intentioned dictator.  This planner wants to maximize the economic well- being of everyone in society.  They want to maximize total surplus. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-71 3a  What do you suppose this planner should do? Should they just leave buyers and sellers at the equilibrium that they reach naturally on their own? Or can they increase economic well-being by altering the market outcome in some way?  To answer this question, the benevolent social planner must first decide how to measure the economic well-being of a society.  One possible measure is the sum of consumer and producer surplus, which we call total surplus.  Consumer surplus is the benefit that buyers receive from participating in a market, and producer surplus is the benefit that sellers receive.  It is therefore natural to use total surplus as a measure of society’s economic well-being. Copyright © 2024 Cengage Learning Canada, Inc. 7-72  MARKET EFFICIENCY THE BENEVOLENT SOCIAL PLANNER (CONT’D)  CS = Value to buyers – Amount paid by buyers  PS = Amount received by sellers – Cost to sellers  TS = Value to buyers – Amount paid by buyers + Amount received by sellers – Cost to 7- sellers = Value to buyers – Cost to sellers Copyright © 2024 Cengage Learning Canada, Inc. 7-73 3a  MARKET EFFICIENCY THE BENEVOLENT SOCIAL PLANNER (CONT’D)  If an allocation of resources maximizes total surplus, we say that the allocation exhibits efficiency.  Efficiency is the property of a resource allocation of maximizing the total surplus received by all members of society. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-74 3a  If an allocation is not efficient, then some of the gains from trade among buyers and sellers are not being realized.  For example, an allocation is inefficient if a good is not being produced by the sellers with lowest cost.  In this case, moving production from a high- cost producer to a low-cost producer will lower the total cost to sellers and raise total surplus. Copyright © 2024 Cengage Learning Canada, Inc. 7-75  MARKET EFFICIENCY THE BENEVOLENT SOCIAL PLANNER (CONT’D)  In addition to efficiency, the social planner might also care about equity.  Equity is the fairness of the distribution of well-being among the members of society.  In this chapter, we concentrate on efficiency as the social planner’s goal.  Policymakers will nevertheless often also care about 7- equity. Copyright © 2024 Cengage Learning Canada, Inc. 7-76 3a  In essence, the gains from trade in a market are like a pie to be distributed among the market participants.  The question of efficiency is whether the pie is as big as possible. The question of equality concerns how the pie is sliced and how the portions are distributed among members of society.  In this chapter, we concentrate on efficiency as the social planner’s goal.  Keep in mind, however, that real policymakers often care about equity as well.  That is, they care about both the size of the economic pie and how the pie gets sliced and distributed among members of society. Copyright © 2024 Cengage Learning Canada, Inc. 7-77  MARKET EFFICIENCY EVALUATING THE MARKET  Figure 7.7 showsEQUILIBRIUM consumer and producer surplus when a market reaches the equilibrium of supply and demand.  Is this equilibrium allocation of resources efficient?  Does it maximize total surplus? 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-78 3b  To answer these questions, keep in mind that when a market is in equilibrium, the price determines which buyers and sellers participate in the market.  Those buyers who value the good more than the price (represented by the segment AE on the demand curve) choose to buy the good; those buyers who value it less than the price (represented by the segment EB) do not.  Similarly, those sellers whose costs are less than the price (represented by the segment CE on the supply curve) choose to produce and sell the good; those sellers whose costs are greater than the price (represented by the segment ED) do not. Copyright © 2024 Cengage Learning Canada, Inc. 7-79  FIGURE 7.7 Consumer and Producer Surplus in the Market Equilibrium 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-80 3b  Total surplus—the sum of consumer and producer surplus—is the area between the supply and demand curves up to the equilibrium quantity. Copyright © 2024 Cengage Learning Canada, Inc. 7-81  MARKET EFFICIENCY EVALUATING THE MARKET EQUILIBRIUM  These observations lead to(CONT’D) two insights about market outcomes: 1. Free markets allocate the supply of goods to the buyers who value them most highly, as measured by their willingness to pay. 2. Free markets allocate the demand for goods to the sellers who can produce them at the lowest cost. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-82 3b  MARKET EFFICIENCY EVALUATING THE MARKET  The social EQUILIBRIUM (CONT’D) planner cannot increase economic well-being by changing the allocation of consumption among buyers or the allocation of production among sellers.  But can the social planner raise total economic well- being by increasing or decreasing the quantity of the good? 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-83 3b  MARKET EFFICIENCY EVALUATING THE MARKET EQUILIBRIUM  The answer is no, as stated(CONT’D) in this third insight about market outcomes: 3. Free markets produce the quantity of goods that maximizes the sum of consumer and producer surplus. 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-84 3b  FIGURE 7.8 The Efficiency of the Equilibrium Quantity 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-85 3b  At quantities less than the equilibrium quantity, such as Q1, the value to buyers exceeds the cost to sellers.  At quantities greater than the equilibrium quantity, such as Q2, the cost to sellers exceeds the value to buyers.  Therefore, the market equilibrium maximizes the sum of producer and consumer surplus. Copyright © 2024 Cengage Learning Canada, Inc. 7-86  MARKET EFFICIENCY EVALUATING THE MARKET  EQUILIBRIUM Suppose the (CONT’D) social planner tried to choose an efficient allocation of resources on their own, instead of relying on market forces.  They would need to know the value of a particular good to every potential consumer in the market and the cost of every potential producer.  The task is practically impossible! 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-87 3b  MARKET EFFICIENCY EVALUATING THE MARKET  EQUILIBRIUM The planner’s (CONT’D) job becomes easy, however, once they take on a partner:  Adam Smith’s invisible hand of the marketplace.  The invisible hand takes all the information about buyers and sellers into account and guides everyone in the market to the best outcome as judged by the standard of economic efficiency.  It is truly a remarkable feat! 7- Copyright © 2024 Cengage Learning Canada, Inc. 7-88 3b  The Mathematics of Consumer and Producer APPENDIX Surplus  In the appendix to Chapter 4, we showed you how to use simple mathematics to determine equilibrium prices and quantities for linear supply and demand curves.  Here we show you how to calculate consumer and producer surplus for linear supply and demand curves. 7A Copyright © 2024 Cengage Learning Canada, Inc. 7-89  The Mathematics of Consumer and Producer APPENDIX Surplus FIGURE 7A.1 Consumer and Producer Surplus with Linear Demand and Supply Curves 7A Copyright © 2024 Cengage Learning Canada, Inc. 7-90  The Mathematics of Consumer and Producer APPENDIX Surplus 7A Copyright © 2024 Cengage Learning Canada, Inc. 7-91  The Mathematics of Consumer and Producer APPENDIX Surplus  Total surplus, which is the total value to buyers measured by their willingness to pay less the total cost to sellers of providing the good, is $96. 7A Copyright © 2024 Cengage Learning Canada, Inc. 7-92 THE END Copyright © 2024 Cengage Learning Canada, Inc. 7-93 SUPPLY, DEMAND, AND GOVERNMENT POLICIES Chapter 6 Copyright © 2024 Cengage Learning Canada, Inc. 6-94 SUPPLY, DEMAND, AND GOVERNMENT POLICIES  This chapter analyzes various types of government policy using only the tools of supply and demand. 1. Policies that directly control prices. 2. The impact of taxes. 6-1 Copyright © 2024 Cengage Learning Canada, Inc. 6-95  For example, policies that directly control prices  Rent control laws, minimum wage legislation  Price controls are enacted when policymakers believe that the market price for a good or service is unfair to buyers or sellers Copyright © 2024 Cengage Learning Canada, Inc. 6-96  If ice cream is sold in a competitive market, free of government regulation, the price adjusts to balance supply and demand  Some people might not be happy with this free market process  Some might think price is too high; some might think price is too low Copyright © 2024 Cengage Learning Canada, Inc. 6-97  Buyers always want a lower price and sellers want a higher price  The interests of the two groups conflict  If the buyers are successful at lobbying the government, the government will impose a legal maximum on the price called a price ceiling  If the sellers are successful at lobbying the government, the government will impose a legal minimum on the price called a price floor Copyright © 2024 Cengage Learning Canada, Inc. 6-98  Impact of taxes  Policymakers use taxes to raise revenue for public purposes and to influence market outcomes Copyright © 2024 Cengage Learning Canada, Inc. 6-99  CONTROLS ON PRICES  What are the effects of the following policies on market outcomes?  Price ceiling is a legal maximum on the price at which a good can be sold.  Price floor is a legal minimum on the price at which a good can be sold. 6-1 Copyright © 2024 Cengage Learning Canada, Inc. 6-100  CONTROLS ON PRICES HOW PRICE CEILINGS AFFECT MARKET OUTCOMES  Assume the government imposes a price ceiling on the market for ice cream.  Two outcomes are possible: 1. The price ceiling is not binding on the market and the market price will equal the equilibrium price. 2. The price ceiling is a binding constraint on the market and the market price will equal the price 6- ceiling. Copyright © 2024 Cengage Learning Canada, Inc. 6-101 1a  FIGURE 6.1 A Market with a Price Ceiling 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-102 1a  In panel (a), the government imposes a price ceiling of $4.  Because the price ceiling is above the equilibrium price of $3, the price ceiling has no effect, and the market can reach the equilibrium of supply and demand.  In this equilibrium, quantity supplied and quantity demanded both equal 100 cones.  In panel (b), the government imposes a price ceiling of $2.  Because the price ceiling is below the equilibrium price of $3, the market price equals $2.  At this price, 125 cones are demanded and only 75 are supplied, so there is a shortage of 50 cones. Copyright © 2024 Cengage Learning Canada, Inc. 6-103  In response to this shortage, some mechanism for rationing ice cream will naturally develop  The mechanism could be long lines  Buyers who are willing to arrive early and wait in line to get a cone, while those unwilling to wait, do not Copyright © 2024 Cengage Learning Canada, Inc. 6-104  Sellers could ration ice cream according to their own personal biases, selling to only friends or relatives  Even though the price ceiling was motivated by a desire to help buyers of ice cream, not all buyers benefit from the policy  Some buyers do get to pay a lower price, although they have to wait inline  Other buyers do not get any ice cream at all Copyright © 2024 Cengage Learning Canada, Inc. 6-105  When the government imposes a binding price ceiling on a competitive market, a shortage of the good arises, and sellers must ration the scarce goods among the largest number of potential buyers  Rationing mechanisms that develop under price ceilings are rarely desirable  Long lines are inefficient, discrimination according to seller bias is inefficient and unfair Copyright © 2024 Cengage Learning Canada, Inc. 6-106  In contrast, the rationing mechanism in a free competitive market is both efficient and impersonal  When the market for ice cream reaches its equilibrium, anyone who wants to pay the market price can get a cone  Free markets ration goods with prices Copyright © 2024 Cengage Learning Canada, Inc. 6-107  case stud Lines at the Gas Pump y 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-108 1a  Panel (a) shows the gasoline market when the price ceiling is not binding because the equilibrium price, P1, is below the ceiling.  Panel (b) shows the gasoline market after an increase in the price of crude oil (an input into making gasoline) shifts the supply curve to the left from S1 to S2.  In an unregulated market the price would have risen from P1 to P2.  The price ceiling, however, prevents this from happening.  At the binding price ceiling, consumers are willing to buy QD, but producers of gasoline are willing to sell only QS.  The difference between quantity demanded and quantity supplied, QD – QS, measures the gasoline shortage. Copyright © 2024 Cengage Learning Canada, Inc. 6-109  case Rent Control in the stud Short Run and the Long y Run 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-110 1a  Figure 6.3 Rent Control in the Short Run and in the Long Run  Panel (a) shows the short-run effects of rent control:  Because supply and demand for apartments are relatively inelastic, the price ceiling imposed by a rent-control law causes only a small shortage of housing.  Panel (b) shows the long-run effects of rent control:  Because supply and demand for apartments are more elastic, rent control causes a large shortage. Copyright © 2024 Cengage Learning Canada, Inc. 6-111  CONTROLS ON PRICES HOW PRICE FLOORS AFFECT MARKET OUTCOMES  Let’s assume that the government imposes a price floor on the market for ice cream.  Two outcomes are possible: 1. The price floor is not binding on the market and the market price will equal the equilibrium price. 2. The price floor is a binding constraint on the market and the market price will equal the price floor. 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-112 1b  FIGURE 6.4 A Market with a Price Floor 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-113 1b  In panel (a), the government imposes a price floor of $2. Because this is below the equilibrium price of $3, the price floor has no effect.  The market price adjusts to balance supply and demand. At the equilibrium, quantity supplied and quantity demanded both equal 100 cones.  In panel (b), the government imposes a price floor of $4, which is above the equilibrium price of $3.  Therefore, the market price equals $4. Because 120 cones are supplied at this price and only 80 are demanded, there is a surplus of 40 cones. Copyright © 2024 Cengage Learning Canada, Inc. 6-114  case stud The Minimum Wage y 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-115 1b  Figure 6.5 How the Minimum Wage Affects the Labour Market  Panel (a) shows a labour market in which the wage adjusts to balance labour supply and labour demand.  Panel (b) shows the impact of a binding minimum wage.  Because the minimum wage is a price floor, it causes a surplus: The quantity of labour supplied exceeds the quantity demanded.  The result is unemployment. Copyright © 2024 Cengage Learning Canada, Inc. 6-116  CONTROLS ON PRICES EVALUATING PRICE CONTROLS  One of the ten principles of economics discussed in Chapter 1 is that markets are usually a good way to organize economic activity.  Prices have the crucial job of balancing supply and demand and thereby coordinating economic activity.  When policymakers set prices by legal decree, they obscure the signals that normally guide the allocation of society’s resources. 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-117 1c  CONTROLS ON PRICES EVALUATING PRICE CONTROLS (CONT’D)  Another of the ten principles of economics is that governments can sometimes improve market outcomes.  Price controls are often aimed at helping the poor.  Rent‐control laws try to make housing affordable for everyone.  Minimum‐wage laws try to help people escape poverty. 6- 1c  Yet price controls often hurt those they are trying to6-118 Copyright © 2024 Cengage Learning Canada, Inc.  TAXES  When the government levies a tax on a good, who bears the burden of the tax?  The people buying the good?  The people selling the good?  Or, if buyers and sellers share the tax burden, what determines how the burden is divided?  Tax incidence is the manner in which the burden of a tax is shared among participants in 6-2 a market. Copyright © 2024 Cengage Learning Canada, Inc. 6-119  TAXES HOW TAXES ON BUYERS AFFECT  MARKET Suppose that OUTCOMES our local government passes a law requiring buyers of ice‐cream cones to send $0.50 to the government for each ice‐cream cone they buy.  How does this law affect the buyers and sellers of ice cream?  Does the law affect the supply curve or demand curve?  Which way does the curve shift? 6- 2a  How does theCopyright shift affect the equilibrium? © 2024 Cengage Learning Canada, Inc. 6-120  TAXES HOW TAXES ON BUYERS AFFECT MARKET OUTCOMES  Using the three (CONT’D) steps from Chapter 4 for analyzing supply and demand:  Step One: The immediate impact of the tax is on the demand for ice cream.  Step Two: We next determine the direction of the shift.  Step Three: Having determined how the demand curve shifts, we can now see the effect of the tax by comparing the initial equilibrium and 6- 2a the new equilibrium. Copyright © 2024 Cengage Learning Canada, Inc. 6-121  FIGURE 6.6 A Tax on Buyers 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-122 2a  When a tax of $0.50 is levied on buyers, the demand curve shifts down by $0.50 from D1 to D2.  The equilibrium quantity falls from 100 to 90 cones.  The price that sellers receive falls from $3.00 to $2.80.  The price that buyers pay (including the tax) rises from $3.00 to $3.30.  Even though the tax is levied on buyers, buyers and sellers share the burden of the tax. Copyright © 2024 Cengage Learning Canada, Inc. 6-123  TAXES HOW TAXES ON BUYERS AFFECT MARKET OUTCOMES  The analysis (CONT’D) yields two lessons: 1. Taxes discourage market activity. 2. Buyers and sellers share the burden of taxes. 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-124 2a  TAXES HOW TAXES ON SELLERS AFFECT MARKET  Suppose the OUTCOMES local government passes a law requiring sellers of ice‐cream cones to send $0.50 to the government for each cone they sell.  What are the effects of this law? 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-125 2b  TAXES HOW TAXES ON SELLERS AFFECT  StepMARKET OUTCOMES One: The tax (CONT’D) on sellers makes the ice-cream business less profitable at any given price, so it shifts the supply curve.  Step Two: Because the tax on sellers raises the cost of producing and selling ice cream, it reduces the quantity supplied at every price. The supply curve shifts to the left.  Step Three: The equilibrium price of ice cream rises 6- from $3.00 to $3.30, and Copyright © 2024 the Cengage equilibrium Learning Canada, Inc. quantity falls 6-126 2b  FIGURE 6.7 A Tax on Sellers 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-127 2b  When a tax of $0.50 is levied on sellers, the supply curve shifts up by $0.50 from S1 to S2.  The equilibrium quantity falls from 100 to 90 cones.  The price that buyers pay rises from $3.00 to $3.30.  The price that sellers receive (after paying the tax) falls from $3.00 to $2.80.  Even though the tax is levied on sellers, buyers and sellers share the burden of the tax. Copyright © 2024 Cengage Learning Canada, Inc. 6-128  TAXES HOW TAXES ON SELLERS AFFECT MARKET  Comparing OUTCOMES Figures 6.6 and 6.7,(CONT’D) taxes on buyers and taxes on sellers are equivalent.  In both cases, the tax places a wedge between the price that buyers pay and the price that sellers receive.  The only difference between taxes on buyers and taxes on sellers is who sends the money to 6- 2b the government. Copyright © 2024 Cengage Learning Canada, Inc. 6-129  TAXES ELASTICITY AND TAX INCIDENCE  How is the tax burden divided?  To see how, consider the impact of taxation in the two markets: 1. A market with very elastic supply and relatively inelastic demand. 2. A market with relatively inelastic supply and very elastic demand. 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-130 2b  FIGURE 6.9 How the Burden of a Tax Is Divided 6- Copyright © 2024 Cengage Learning Canada, Inc. 6-131 2c  In panel (a), the supply curve is elastic, and the demand curve is inelastic.  In this case, the price received by sellers falls only slightly, while the price paid by buyers rises substantially.  Thus, buyers bear most of the burden of the tax.  In panel (b), the supply curve is inelastic, and the demand curve is elastic.  In this case, the price received by sellers falls substantially, while the price paid by buyers rises only slightly.  Thus, sellers bear most of the burden of the tax. Copyright © 2024 Cengage Learning Canada, Inc. 6-132  THE MATHEMATICS OF MARKET APPENDIX EQUILIBRIUM WITH TAXES  Chapter 6 showed that when a tax is imposed on a good, there are, in effect, two types of prices in equilibrium because the tax places a wedge between the price that buyers pay and the price that sellers receive. 6A Copyright © 2024 Cengage Learning Canada, Inc. 6-133  THE MATHEMATICS OF MARKET APPENDIX EQUILIBRIUM WITH TAXES Without tax With tax paid by buyers With tax = $1.50 per unit 6A Copyright © 2024 Cengage Learning Canada, Inc. 6-134  THE MATHEMATICS OF MARKET APPENDIX EQUILIBRIUM WITH TAXES Equilibrium price received by the sellers in the presence of the $1.50 tax levied on the buyers. The price paid by buyers, including the tax; note that it is simply the price received by sellers plus the tax. 6A Copyright © 2024 Cengage Learning Canada, Inc. 6-135  THE MATHEMATICS OF MARKET APPENDIX EQUILIBRIUM WITH TAXES Substituting the price paid by buyers, PB, into the demand curve gives the equilibrium quantity demanded in thequantity The equilibrium presence of the tax. is given by supplied substituting the price received by sellers, PS, into the supply The tax therefore shrinks the size of the market by 2 units, curve. from 16 to 14. 6A Copyright © 2024 Cengage Learning Canada, Inc. 6-136  FIGURE 6A.1 Market Equilibrium with Linear Demand and Supply Curves and a Tax on Buyers 6A Copyright © 2024 Cengage Learning Canada, Inc. 6-137  This figure illustrates the market equilibrium for linear demand and supply curves given by the equations QD = 56 – 4P and QS = 4 + 2P.  In the absence of the tax, the equilibrium price is determined by setting QD = QS and solving for P = $10.  When a tax of $1.50 per unit is imposed on buyers of the good, a wedge is driven between the price paid by buyers (PB) and the price paid by sellers (PS), PB = PS + $1.50.  The demand curve becomes QD = 50 – 4PS.  Again setting QD = QS and solving for PS = $9 gives the seller’s price of the good.  The “buyer’s price” is PB = PS + $1.50 = $9 + $1.50 = $10.50, and the equilibrium quantity drops from 16 to 14. Copyright © 2024 Cengage Learning Canada, Inc. 6-138  THE MATHEMATICS OF MARKET APPENDIX EQUILIBRIUM WITH TAXES If the tax were imposed on the sellers, the demand and supply curves would look like this: 6A Copyright © 2024 Cengage Learning Canada, Inc. 6-139 THE END Copyright © 2024 Cengage Learning Canada, Inc. 6-140 ELASTICITY AND ITS APPLICATION Chapter 5 Copyright © 2024 Cengage Learning Canada, Inc. 5-141  Imagine some event drives up the price of gasoline in Canada  Such as war in the Middle East disrupting the world supply of oil, a booming Chinese economy that boosts world demand for oil or a new tax on gasoline  How would Canadian consumers respond to the higher price? Copyright © 2024 Cengage Learning Canada, Inc. 5-142  Easy answer: they would buy less gas (law of demand)  By how much did the consumption of gas fall?  This question can be answered by using the concept of elasticity Copyright © 2024 Cengage Learning Canada, Inc. 5-143 ELASTICITY AND ITS APPLICATION  Elasticity is a measure of how much buyers and sellers respond to changes in market conditions.  When studying how an event or policy affects a market, we can discuss not only the direction of the effects but also their magnitude.  Elasticity is useful in many applications, as we 5 will see toward the end of the chapter. Copyright © 2024 Cengage Learning Canada, Inc. 5-144 ELASTICITY AND ITS APPLICATION  To measure how much consumers respond to changes in these variables, economists use the concept of elasticity.  Elasticity is a measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants. 5 Copyright © 2024 Cengage Learning Canada, Inc. 5-145  THE ELASTICITY OF DEMAND THE PRICE ELASTICITY OF DEMAND AND ITS DETERMINANTS  Price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-146 1a  Demand for a good is said to be elastic if the quantity demanded responds substantially to changes in the price  Demand for a good is said to be inelastic if the quantity demanded responds only slightly to changes in the price Copyright © 2024 Cengage Learning Canada, Inc. 5-147  THE ELASTICITY OF DEMAND THE PRICE ELASTICITY OF DEMAND AND ITS DETERMINANTS (CONT’D)  What influences the elasticity of demand?  Availability of close substitutes  Necessities versus luxuries  Definition of the market  Time horizon 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-148 1a  Availability of close substitutes: a good with close substitutes tends to have more elastic demand because it is easier for consumers to switch from that good to others  Butter and margarine are easily substitutable  A small increase in the price of butter, assuming the price of margarine is held fixed, causes the quantity of butter to fall by a large amount Copyright © 2024 Cengage Learning Canada, Inc. 5-149  Because eggs are a food without a close substitute, the demand for eggs is less elastic than the demand for butter  A small increase in the price of eggs does not cause a sizable drop in the quantity of eggs sold Copyright © 2024 Cengage Learning Canada, Inc. 5-150  Necessities vs luxuries: necessities tend to have inelastic demands whereas luxuries tend to have elastic demands  When the price of a dentist visit rises, people do not dramatically alter the number of times they go to the dentist  When the price of sailboats rises, the quantity of sailboats demanded falls dramatically  Depends on preferences of the buyer Copyright © 2024 Cengage Learning Canada, Inc. 5-151  Definition of the market: the elasticity in any market depends on how we draw the boundaries of the market  Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods  Food, a broad category has fairly inelastic demand because there are no substitutes for food  Ice cream, a narrower category, has a more elastic demand because it is easy to substitute other desserts for ice cream Copyright © 2024 Cengage Learning Canada, Inc. 5-152  Time horizon: goods tend to have more elastic demand over longer time horizons  When the price of gasoline rises, the quantity of gasoline demanded falls only slightly in the first few months  Over time, however, people buy more fuel efficient cars or switch to public transportation  Within several years, the quantity of gasoline demanded falls substantially Copyright © 2024 Cengage Learning Canada, Inc. 5-153  THE ELASTICITY OF DEMAND COMPUTING THE PRICE ELASTICITY OF DEMAND 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-154 1b  THE ELASTICITY OF DEMAND COMPUTING THE PRICE ELASTICITY OF DEMAND  For example, suppose a 10 percent(CONT’D) increase in the price of an ice- cream cone causes the amount of ice cream you buy to fall by 20 percent.  The elasticity is 2, meaning that the change in the quantity demanded is proportionately twice as large as the change in the price.  Elasticity is a unitless measure, which is independent of the units that the quantity demanded, or the price is measured in. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-155 1b  Because the quantity demanded of a good is negatively related to its price, the percentage change in quantity will always have the opposite sign as the percentage change in price  In this example, the percentage change in is a positive 10 percent (reflecting an increase), and the percentage change in quantity demanded is a negative 20 percent (reflecting a decrease) Copyright © 2024 Cengage Learning Canada, Inc. 5-156  For this reason, price elasticities of demand are sometimes reported as negative numbers  In this course, we will follow the common practice of dropping the minus sign and reporting all price elasticities of demand as positive numbers (absolute value)  With this convention, a larger price elasticity implies a greater responsiveness of quantity demanded to changes in price Copyright © 2024 Cengage Learning Canada, Inc. 5-157  THE ELASTICITY OF DEMAND THE MIDPOINT METHOD  If you try calculating the price elasticity of demand between two points on a demand curve, you will quickly notice an annoying problem:  The elasticity from point A to point B seems different from the elasticity from point B to point A. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-158 1c  THE ELASTICITY OF DEMAND THE MIDPOINT METHOD (CONT’D)  For example: Quantity = Point A: Price = $4 120 Point B: Price = $6 Quantity = 80  From point A to point B, the price rises by 50 percent, and the quantity falls by 33 percent, PED = 0.66.  From point B to point A, the price falls by 33 percent, and the quantity rises by 50 percent, PED = 1.5. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-159 1c  THE ELASTICITY OF DEMAND THE MIDPOINT METHOD (CONT’D)  With the midpoint method: Quantity = Price = $5 100  From point A to point B, the price rises by 40 percent and the quantity falls by 40 percent.  From point B to point A, the price falls by 40 percent and the quantity rises by 40 percent.  In both directions, PED = 1. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-160 1c  THE ELASTICITY OF DEMAND THE MIDPOINT METHOD (CONT’D) 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-161 1c  The numerator is the percentage change in quantity computed using the midpoint method, and the denominator is the percentage change in price computed using the midpoint method.  If you ever need to calculate elasticities, you should use this formula. Copyright © 2024 Cengage Learning Canada, Inc. 5-162  THE ELASTICITY OF DEMAND THE VARIETY OF DEMAND CURVES  Demand curves are classified according to their elasticity.  Demand is elastic when the elasticity is greater than 1, so that quantity moves proportionately more than the price.  Demand is inelastic when the elasticity is less than 1, so that quantity moves proportionately less than the price.  If the elasticity is exactly 1, so that quantity moves the same amount proportionately as price, demand is said to have unit elasticity. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-163 1d  The flatter the demand curve that passes through a given point, the greater the price elasticity of demand  The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand Copyright © 2024 Cengage Learning Canada, Inc. 5-164  FIGURE 5.1 The Price Elasticity of Demand 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-165 1d  FIGURE 5.1 The Price Elasticity of Demand 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-166 1d  FIGURE 5.1 The Price Elasticity of Demand 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-167 1d  The price elasticity of demand determines whether the demand curve is steep or flat. Note that all percentage changes are calculated using the midpoint method.  Demand curves are classified according to their elasticity.  Demand is elastic when the elasticity is greater than 1, so that quantity moves proportionately more than the price.  Demand is inelastic when the elasticity is less than 1, so that quantity moves proportionately less than the price  If the elasticity is exactly 1, so that quantity moves the same amount proportionately as price, demand is said to have unit elasticity. Copyright © 2024 Cengage Learning Canada, Inc. 5-168  THE ELASTICITY OF DEMAND TOTAL REVENUE AND THE PRICE ELASTICITY  Total revenue OF DEMAND (in a market) is the amount paid by buyers and received by sellers of a good, computed as the price of the good times the quantity sold. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-169 1e  When studying changes in supply or demand in a market, one variable we want to study is Total Revenue Copyright © 2024 Cengage Learning Canada, Inc. 5-170  FIGURE 5.2 Total Revenue 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-171 1e  The total amount paid by buyers, and received as revenue by sellers, equals the area of the box under the demand curve, P × Q.  Here, at a price of $4, the quantity demanded is 100, and total revenue is $400. Copyright © 2024 Cengage Learning Canada, Inc. 5-172  THE ELASTICITY OF DEMAND TOTAL REVENUE AND THE PRICE ELASTICITY OF DEMAND (CONT’D)  How does total revenue change as one moves along the demand curve?  It depends on the price elasticity of demand. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-173 1e  THE ELASTICITY OF DEMAND TOTAL REVENUE AND THE PRICE ELASTICITY OF DEMAND (CONT’D)  The examples in Figure 5.3 illustrate some general rules: 1. When demand is inelastic (a price elasticity less than 1), price and total revenue move in the same direction. 2. When demand is elastic (a price elasticity greater than 1), price and total revenue move in opposite directions. 3. If demand is unit elastic (a price elasticity exactly equal to 1), total revenue remains constant when the price changes. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-174 1e  FIGURE 5.3 How Total Revenue Changes When Price Changes 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-175 1e  The impact of a price change on total revenue (the product of price and quantity) depends on the elasticity of demand.  In panel (a), the demand curve is inelastic.  In this case, an increase in the price leads to a decrease in quantity demanded that is proportionately smaller, so total revenue increases.  Here, an increase in the price from $4 to $5 causes the quantity demanded to fall from 100 to 90.  Total revenue rises from $400 to $450.  Area A is the extra revenue from selling units at a higher price; it is equal to ($5 – $4) × 90 = $90.  Area B is the decline in revenue from selling fewer units; it is equal to $4 × (100 – 90) = $40. Copyright © 2024 Cengage Learning Canada, Inc. 5-176  Area A is larger than area B by $50, which is the increase in revenue from an increase in the price from $4 to $5.  In panel (b), the demand curve is elastic.  In this case, an increase in the price leads to a decrease in quantity demanded that is proportionately larger, so total revenue decreases.  Here, an increase in the price from $4 to $5 causes the quantity demanded to fall from 100 to 70.  Total revenue falls from $400 to $350.  In this case, the extra revenue from selling units at a higher price (area A) is equal to $70, and the decline in revenue from selling fewer units (area B) is $120.  In this case, area A is smaller than area B by $50, which is the decrease in revenue from an increase in the price from $4 to $5. Copyright © 2024 Cengage Learning Canada, Inc. 5-177  When demand is inelastic, (a price elasticity of less than 1), price and total revenue move in the same direction: if the price increases, the total revenue increases  When demand is elastic, (a price elasticity of more than 1), price and total revenue move in opposite directions: if the price increases, the total revenue decreases  If demand is unit elastic (a price elasticity exactly equal to 1), total revenue remains constant when the price changes Copyright © 2024 Cengage Learning Canada, Inc. 5-178  THE ELASTICITY OF DEMAND ELASTICITY AND TOTAL REVENUE ALONG A LINEAR DEMAND CURVE  A straight line has a constant slope.  The slope of a linear demand curve is constant, but the elasticity is not.  The slope is the ratio of changes in the two variables.  The elasticity is the ratio of percentage changes in the two variables. 5-1f Copyright © 2024 Cengage Learning Canada, Inc. 5-179  FIGURE 5.4 Elasticity of a Linear Demand Curve 5-1f Copyright © 2024 Cengage Learning Canada, Inc. 5-180  The slope of a linear demand curve is constant, but its elasticity is not.  The demand schedule in the table was used to calculate the price elasticity of demand by the midpoint method.  At points with a low price and high quantity, the demand curve is inelastic.  At points with a high price and low quantity, the demand curve is elastic. Copyright © 2024 Cengage Learning Canada, Inc. 5-181  THE ELASTICITY OF DEMAND OTHER DEMAND ELASTICITIES  In addition to the price elasticity of demand, economists also use other elasticities to describe the behaviour of buyers in a market: 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-182 1g  The income elasticity of demand measures how much the quantity demanded changes as consumer income changes  Most goods are normal goods  Because quantity demanded and income move in the same direction, normal goods have positive income elasticities Copyright © 2024 Cengage Learning Canada, Inc. 5-183  A few goods, such as bus rides are inferior goods  Higher income lowers the quantity demanded  Because quantity demanded and income move in opposite directions, inferior goods have negative income elasticities Copyright © 2024 Cengage Learning Canada, Inc. 5-184  Even among normal goods, income elasticities vary substantially in size  Necessities, such as food and clothing, tend to have small income elasticities because consumers choose to buy some of these goods even when their incomes are low  As a family’s income rises, the percent of its income spent on food declines, indicating an income elasticity of less than 1 Copyright © 2024 Cengage Learning Canada, Inc. 5-185  By contrast, luxury goods, such as jewellery and recreational goods tend to have large income elasticities because consumers feel that they can do without these goods altogether if their incomes are too low Copyright © 2024 Cengage Learning Canada, Inc. 5-186  Cross price elasticity of demand measures how the quantity demanded of one good responds to a change in the price of another good  Whether the cross-price elasticity is positive or negative depends on whether the 2 goods are substitutes or complements  For substitutes, the cross-price elasticity is positive Copyright © 2024 Cengage Learning Canada, Inc. 5-187  An increase in hot dog prices causes people to buy more hamburgers  For complements, the cross-price elasticity is negative  An increase in the price of computers reduces the quantity of software demanded Copyright © 2024 Cengage Learning Canada, Inc. 5-188  THE ELASTICITY OF SUPPLY THE PRICE ELASTICITY OF SUPPLY AND ITS DETERMINANTS  Price elasticity of supply is a measure of how much the quantity supplied of a good responds to a change in the price of that good, computed as the percentage change in quantity supplied divided by the percentage change in price. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-189 2a  THE ELASTICITY OF SUPPLY THE PRICE ELASTICITY OF SUPPLY AND ITS DETERMINANTS (CONT’D)  Supply of a good is said to be:  Elastic if the quantity supplied responds substantially to changes in the price.  Inelastic if the quantity supplied responds only slightly to changes in the price.  Supply is usually more elastic in the long run than in the short run. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-190 2a  Active Learning Elasticity and Changes in Equilibrium The supply of beachfront property is inelastic. The supply of new cars is elastic. Suppose population growth causes demand for both goods to double (at each price, QD doubles). 1. For which product will P change the most? 2. For which product will Q change the most? 5-2 Copyright © 2024 Cengage Learning Canada, Inc. 5-191  Active Learning Answers Beachfront property (inelastic P supply): 1. When supply D1 D2 S is inelastic, an increase in P2 B demand has a bigger impact on P1 A price than on quantity. Q Q1 Q2 5-2 Copyright © 2024 Cengage Learning Canada, Inc. 5-192  Active Learning Answers New cars (elastic supply): P 2. When supply D1 D2 is elastic, an increase in S demand has a B bigger impact on P2 A P1 quantity than on price. Q Q1 Q2 5-2 Copyright © 2024 Cengage Learning Canada, Inc. 5-193  THE ELASTICITY OF SUPPLY COMPUTING THE PRICE ELASTICITY OF SUPPLY 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-194 2b  THE ELASTICITY OF SUPPLY COMPUTING THE PRICE ELASTICITY OF SUPPLYin(CONT’D)  Suppose an increase the price of milk from $2.85 to $3.15 per 4 L container raises the amount that dairy farmers produce from 9000 L to 11 000 L per month.  Using the midpoint method, the percentage change in price is: 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-195 2b  THE ELASTICITY OF SUPPLY COMPUTING THE PRICE ELASTICITY OF  Similarly, weSUPPLY calculate (CONT’D) the percentage change in quantity supplied as: Percentage change in quantity supplied = (11 000 ̶ 9000) / 10 000 × 100 = 20 percent 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-196 2b  THE ELASTICITY OF SUPPLY THE VARIETY OF SUPPLY CURVES  Because the price elasticity of supply measures the responsiveness of quantity supplied to the price, it is reflected in the appearance of the supply curve. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-197 2c  FIGURE 5.5 The Price Elasticity of Supply 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-198 2c  The price elasticity of supply determines whether the supply curve is steep or flat. Note that all percentage changes are calculated using the midpoint method.  Figure 5.5 shows five cases. In the extreme case of a zero elasticity, as shown in panel (a), supply is perfectly inelastic and the supply curve is vertical.  In this case, the quantity supplied is the same regardless of the price.  As the elasticity rises, the supply curve gets flatter, which shows that the quantity supplied responds more to changes in the price.  At the opposite extreme, shown in panel (e), supply is perfectly elastic.  This occurs as the price elasticity of supply approaches infinity and the supply curve becomes horizontal, meaning that very small changes in the price lead to very large changes in the quantity supplied. Copyright © 2024 Cengage Learning Canada, Inc. 5-199  FIGURE 5.5 The Price Elasticity of Supply 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-200 2c  FIGURE 5.5 The Price Elasticity of Supply 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-201 2c  FIGURE 5.6 How the Price Elasticity of Supply Can Vary 5 Copyright © 2024 Cengage Learning Canada, Inc. 5-202  In some markets, the elasticity of supply is not constant but varies over the supply curve.  Figure 5.6 shows a typical case for an industry in which firms have factories with a limited capacity for production.  For low levels of quantity supplied, the elasticity of supply is high, indicating that firms respond substantially to changes in the price.  In this region, firms have capacity for production that is not being used, such as plants and equipment sitting idle for all or part of the day.  Small increases in price make it profitable for firms to begin using this idle capacity. As the quantity supplied rises, firms begin to reach capacity. Once capacity is fully used, increasing production further requires the construction of new plants. Copyright © 2024 Cengage Learning Canada, Inc. 5-203  To induce firms to incur this extra expense, the price must rise substantially, so supply becomes less elastic.  Because firms often have a maximum capacity for production, the elasticity of supply may be very high at low levels of quantity supplied and very low at high levels of quantity supplied.  Here, an increase in price from $3 to $4 increases the quantity supplied from 100 to 200.  Because the increase in quantity supplied of 67 percent (computed using the midpoint method) is larger than the increase in price of 29 percent, the supply curve is elastic in this range.  By contrast, when the price rises from $12 to $15, the quantity supplied rises only from 500 to 525.  Because the increase in quantity supplied of 5 percent is smaller than the increase in price of 22 percent, the supply curve is inelastic in this range. Copyright © 2024 Cengage Learning Canada, Inc. 5-204  THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY 1. Can good news for farming be bad news for farmers? 2. Why did the Organization of the Petroleum Exporting Countries (OPEC) international oil cartel in the 1970s and 80s and, more recently, the COVID-19 pandemic have on oil prices? 3. Does drug interdiction increase or decrease drug-related crime? 5-3 Copyright © 2024 Cengage Learning Canada, Inc. 5-205  THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY FARMING AND FARMERS  Because hybrid wheat increases the amount of wheat that can be produced on each hectare of land, farmers are now willing to supply more wheat at any given price. In other words, the supply curve shifts to the right.  Does this discovery make farmers better off? 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-206 3a  FIGURE 5.7 An Increase in Supply in the Market for Wheat 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-207 3a  When an advance in farm technology increases the supply of wheat from S1 to S2, the price of wheat falls.  Because the demand for wheat is inelastic, the increase in the quantity sold from 100 to 110 is proportionately smaller than the decrease in the price from $3 to $2.  As a result, farmers’ total revenue falls from $300 ($3 × 100) to $220 ($2 × 110). Copyright © 2024 Cengage Learning Canada, Inc. 5-208  THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY OPEC, COVID-19, AND THE PRICE OF  In the 1970s, membersOIL of OPEC decided to raise the world price of oil by reducing supply.  They did the same in 1979 to 1981.  In the short run, both the supply and demand for oil are relatively inelastic.  Over long periods of time, supply-and-demand curves are more elastic. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-209 3b  FIGURE 5.8 A Reduction in Supply in the World Market for Oil 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-210 3b  When the supply of oil falls, the response depends on the time horizon.  In the short run, supply and demand are relatively inelastic, as in panel (a).  Thus, when the supply curve shifts from S1 to S2, the price rises substantially.  By contrast, in the long run, supply and demand are relatively elastic, as in panel (b).  In this case, a similar size shift in the supply curve (S1 to S2) causes a smaller increase in the price. Copyright © 2024 Cengage Learning Canada, Inc. 5-211  THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY OPEC, COVID-19, AND THE PRICE OF  OILplayed More recently, COVID-19 (CONT’D) havoc with the oil market in 2020.  Consumers drove less, offices and plants shut down, and both leisure and business air travel virtually disappeared.  The pandemic resulted in a large shift to the left in the demand for oil, leading to a dramatic decline in the price of oil because supply is inelastic.  In 2020, oil prices fell by over 70 percent from January to April, even becoming negative in April. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-212 3b  THREE APPLICATIONS OF SUPPLY, DEMAND, AND ELASTICITY DRUGS  To discourage the use of illegal drugs, the Canadian government devotes millions of dollars each year to reducing the flow of drugs into the country.  Let’s use the tools of supply and demand to examine this policy of drug interdiction. 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-213 3c  FIGURE 5.9 Policies to Reduce the Use of Illegal Drugs 5- Copyright © 2024 Cengage Learning Canada, Inc. 5-214 3c  Drug interdiction reduces the supply of drugs from S1 to S2, as shown in panel (a).  If the demand for drugs is inelastic, then the total amount paid by drug users rises, even as the amount of drug use falls.  By contrast, drug education reduces the demand for drugs from D1 to D2, as shown in panel (b).  Because both price and quantity fall, the amount paid by drug users falls. Copyright © 2024 Cengage Learning Canada, Inc. 5-215 THE END Copyright © 2024 Cengage Learning Canada, Inc. 5-216 THE MARKET FORCES OF SUPPLY AND DEMAND Chapter 4 Copyright © 2024 Cengage Learning Ltd. 4-217  THE MARKET FORCES OF SUPPLY AND DEMAND  Supply and demand are words often used by economists.  They are what make market economies work.  They determine the quantity of each good produced and the price at which it is sold.  If you want to know how any event or policy will affect the economy, you must think first about how it will affect supply and demand. 4 Copyright © 2024 Cengage Learning Ltd. 4-218  MARKETS AND COMPETITION  The terms supply and demand refer to the behaviour of people as they interact with one another in competitive markets. 4-1 Copyright © 2024 Cengage Learning Ltd. 4-219  MARKETS AND COMPETITION  MARKET:WHAT IS A MARKET? a group of buyers and sellers of a particular good or service  Buyers as a group determine the demand for the product.  Sellers as a group determine the supply of the product. 4- Copyright © 2024 Cengage Learning Ltd. 4-220 1a  MARKETS AND COMPETITION WHAT IS A MARKET? (CONT’D)  Markets take many forms:  Highly organized  Markets for many agricultural commodities  Less organized  Market for ice cream in a particular town 4- Copyright © 2024 Cengage Learning Ltd. 4-221 1a  The market for ice cream, like most markets in the economy, is highly competitive. Each buyer knows that there are several sellers from which to choose, and each seller is aware that his or her product is similar to that offered by other sellers. As a result, the price of ice cream and the quantity of ice cream sold are not determined by any single buyer or seller. Rather, price and quantity are determined by all buyers and sellers as they interact in the marketplace. Copyright © 2024 Cengage Learning Ltd. 4-222  MARKETS AND COMPETITION WHAT IS COMPETITION?  COMPETITIVE MARKET: a market in which there are many buyers and many sellers so that each has a negligible impact on the market price  Price and quantity are determined by all buyers and sellers as they interact in the marketplace 4- Copyright © 2024 Cengage Learning Ltd. 4-223 1b  A competitive market is a market in which there are many buyers and many sellers so that each has a negligible impact on the market price. Most markets in the economy are highly competitive. Each buyer notes that there are several sellers from which to choose. Each seller is aware that their product is similar to that offered by other sellers. Economists use the term competitive market to describe a market in which there are so many buyers and so many sellers that each has a negligible impact on the market4-224 Copyright © 2024 Cengage Learning Ltd. price.  MARKETS AND COMPETITION  InWHAT IS COMPETITION? this chapter, (CONT’D) it is assumed that markets are perfectly competitive.  Goods offered for sale are all exactly the same.  Buyers and sellers are so numerous that no single buyer or seller has any influence over the market price.  Buyers and sellers are price takers. 4- Copyright © 2024 Cengage Learning Ltd. 4-225 1b  MARKETS AND COMPETITION WHAT IS COMPETITION? (CONT’D)  At the market price  Buyers can buy all they want  Sellers can sell all they want  Not all goods and services are sold in perfectly competitive markets.  Monopoly: One seller in the market and this seller sets the price 4-  Other markets fall between Copyright perfect © 2024 Cengage Learning Ltd. competition and 4-226 1b  Your local cable television company, for instance, may be a monopoly. Residents of your small town probably have only one cable company from which to buy this service. Still other markets fall between the extremes of perfect competition and monopoly.  Despite the diversity of market types we find in the world, assuming perfect competition is a useful simplification and, therefore, a natural place to start.  Perfectly competitive markets are the easiest to analyze because everyone participating in the market takes the price as given by market conditions. Copyright © 2024 Cengage Learning Ltd. 4-227  DEMAND THE DEMAND CURVE: THE RELATIONSHIP BETWEEN PRICE AND QUANTITY DEMANDED  QUANTITY DEMANDED: the amount of a good that buyers are willing and able to purchase  LAW OF DEMAND: the claim that, other things equal, the quantity demanded of a good falls when the price of the good rises 4- Copyright © 2024 Cengage Learning Ltd. 4-228 2a  Our study begins by examining the behaviour of buyers.  Quantity demanded is the amount of a good that buyers are willing and able to purchase. Quantity demanded is negatively related to the price because as price rises, quantity demanded falls.  It is straightforward finding examples for which students can relate to the law of demand. For example, increases in tuition fees, increases in the price of smartphones, increases in the price of restaurant meals, and so on are all examples where students can easily identify an increase in price and how they would react to it. Copyright © 2024 Cengage Learning Ltd. 4-229  One can also give or ask for examples of cases where the law of demand is not respected. One such example would be where house prices increase and that the demand for houses also increases at the same time. This appears to violate the law of demand; however, what is really happening is that other factors are at play here and the condition of “other things equal” is not holding. This will become obvious later in this chapter and a more complete explanation of this phenomenon will be provided once the supply curve is introduced. Copyright © 2024 Cengage Learning Ltd. 4-230  DEMAND THE DEMAND CURVE: THE RELATIONSHIP  DEMAND SCHEDULE: a table that shows the BETWEEN PRICE AND QUANTITY relationship between the(CONT’D) DEMANDED price of a good and the quantity demanded  DEMAND CURVE: a graph of the relationship between the price of a good and the quantity demanded 4- Copyright © 2024 Cengage Learning Ltd. 4-231 2a  FIGURE 4.1 Catherine’s Demand Schedule and Demand Curve 4- Copyright © 2024 Cengage Learning Ltd. 3-232 2a  The demand schedule shows the quantity demanded at each price.  The demand curve, which graphs the demand schedule, shows how the quantity demanded of the good changes as its price varies.  Because a lower price increases the quantity demanded, the demand curve slopes downward. Copyright © 2024 Cengage Learning Ltd. 4-233  DEMAND MARKET DEMAND VERSUS INDIVIDUAL  MARKET DEMAND: the sum of all the DEMAND individual demands for a particular good or service 4- Copyright © 2024 Cengage Learning Ltd. 4-234 2b  FIGURE 4.2 Market Demand as the Sum of Individual Demands 4- Copyright © 2024 Cengage Learning Ltd. 3-235 2b  The quantity demanded in a market is the sum of the quantities demanded by all the buyers at each price.  Thus, the market demand curve is found by adding horizontally the individual demand curves.  At a price of $4, Catherine demands 4 ice-cream cones, and Nicholas demands 3 ice-cream cones.  The quantity demanded in the market at this price is 7 cones. Copyright © 2024 Cengage Learning Ltd. 4-236  DEMAND SHIFTS IN THE DEMAND CURVE  Any change that increases the quantity demanded at every price shifts the demand curve to the right and is called an increase in demand.  Any change that reduces the quantity demanded at every price shifts the demand curve to the left and is called a decrease in demand. 4- Copyright © 2024 Cengage Learning Ltd. 4-237 2c  The demand curve for ice cream shows how much ice cream people buy at any given price, holding constant the many other factors beyond price that influence consumers’ buying decisions. Consequently, the demand curve need not be static over time but is likely dynamic; that is, shifting continuously.  For example, if the Canadian Medical Association discovered that people live longer if they eat peanuts every day, then the demand curve for peanuts would shift to the right for any given price. Copyright © 2024 Cengage Learning Ltd. 4-238  FIGURE 4.3 Shifts in the Demand Curve 4- Copyright © 2024 Cengage Learning Ltd. 3-239 2c  Any change that raises the quantity that buyers wish to purchase at a given price shifts the demand curve to the right.  Any change that lowers the quantity that buyers wish to purchase at a given price shifts the demand curve to the left. Copyright © 2024 Cengage Learning Ltd. 4-240  DEMAND SHIFTS IN THE DEMAND CURVE  Factors that shift(CONT’D ) curve: the de