Dellibro:Economía, PaulA. Samuelson yWilliamD.

Nordhaus, McGraw-Hill Interamericana, 2003

4
APPLICATIONS OF THE OFFER
AND FROM THE DEMAND

You can't teach a parrot.

to be an economist simply by teaching him
to say "supply" and "demand".

ANONYMOUS

We now move from our introductory analysis to a detailed a competitive market. We also examine the failures
of the study of microeconomics, that is, of the behavior of from the market that arise when an industry is dominated
the different companies, consumers, and markets. The mer- nothing due to monopolies or other types of competitors
cados contain most of the great reach and of the great perfect. Later we will examine the markets of
drama of economic history and of the controversies of the factors and the role of the State in a mixed economy
economic policy. Within the limits of microeco- the
mine we studied the causes of the great differences between
the income of neurosurgeons and the income of the workers
textile workers. Microeconomics is fundamental for
understand why the prices of the com have fallen so much
computers and why their expansion has increased exponentially A. THE ELASTICITY OF DEMAND
use. Do not expect the reader to understand the heated debates AND OF THE OFFER
about healthcare or about the minimum wage without
apply the instruments of supply and demand to these The theory of supply and demand can be used to provide
sectors. Even some issues like drugs or delinquency response to a wide range of practical issues.
sequence and the corresponding sentences are understood me- When a new tax on gasoline is established,
I am examining the difference between the demand for substances Do motorists bear the burden of this tax or does it fall on others?
addictive and that of other goods. en las compañías petrolíferas? ¿Beneficia una subida del sa-
But to understand supply and demand is not enough lario mínimo a los trabajadores o los perjudica? Cuando las
by simply pronouncing the words like a parrot. Pa- airlines lower their fares, does the number of increases so much?
to fully master microeconomic analysis there is passengers that actually increase the total income?
to understand how demand curves are obtained and To convert supply and demand into instruments
about the offer, one must learn the different concepts of cos- to be truly useful, we need to know how many respond
you have to understand how it differs from perfect competition give the variations of prices. Some purchases, like
of the monopoly. We will address all these and other topics. vacation travel ones are very sensitive to the variations
but when we explore the fascinating world of the microe- neither from the prices. Others, such as those for food or electricity-
Economy. Dad, they are necessary and barely respond to the variations of
Our analysis of microeconomics begins with a the prices. The quantitative relationship between the price and the q
study of the product markets, which are the mar- Dad bought it, it is analyzed using the fundamental concept.
two of goods and services. We see where it comes from the de- elasticity. We will reap the fruits of this new con-
consumer demand, how they make decisions except in the second half of the chapter, when we examine
companies and how prices and profits coordinate the microeconomic repercussions of taxes and of
demand the allocation of scarce economic resources in other types of state intervention.

57
58 ECONOMY

PRICE ELASTICITY OF DEMAND exact definition of price elasticity, ED, it is the variation
percentage of the quantity demanded divided by the varia-
Let's examine, first of all, the response to the demand for percentage change of the price. We remove the negative sign for
consumers to price variations. comfort, so the elasticities are all positive.
The price elasticity coefficient is calculated numerically.
The price elasticity of demand (referred to as a clearly in accordance with the following formula:
price elasticity) indicates how much the quantity varies
demand for a good when its price changes. Its
the exact definition is the percentage variation of the can-
Price elasticity of demand = ED=
demand quantity divided by the percentage change
of the price. Percentagevariationofthequantitydemanded
=–––––––––––––––––––––––––––––––––––––––––
Percentagevariationoftheprice
Price elasticity, that is, the sensitivity to changes in
the prices, varies enormously from one good to Now we can be more precise about the different classes.
others. When it is high, we say that the good has a demand of price elasticity:
"elastic", which means that the quantity demanded res- ● When a price variation of 1 per 100 causes
it responds extraordinarily to changes in its price.
When it is low, it is "inelastic" and the quantity demanded ape-
a variation in the quantity demanded greater than that
percentage, we have an elastic demand in relation to
nas responds to changes in its price.
to the price. For example, if a price increase of 1
The demand for essential goods, such as food, the for every 100, the quantity demanded decreases by 5 percent,
fuels, shoes, and prescription medications,
well has a very elastic demand with respect to
tends to be inelastic. These items constitute the basis of
price.
life is not easy to give up on them when their price rises. ● When a price variation of 1 percent causes
Instead, it is easy to replace luxury goods, such as a
a variation in the quantity demanded lower than that by-
holidays in Europe, a 17-year-old Scotch whisky and the percentage, good has an inelastic demand with re-
clothing from an Italian designer, when its price rises.
I expect the price. This case occurs, for example, when a
The demand for goods that are easily substituted for others
tends to be more elastic than the demand of those who do not have
an increase in price of 1 percent only causes a decrease in
a decrease in demand of 0.2 percent.
substitutes. If prices rose by 20 percent tomorrow ● An important special case is the elastic demand lawsuit.
all food or all footwear, it would be difficult
unitary gift, which occurs when the percentage variation
to expect that people would stop eating or would be barefoot,
The total amount is exactly the same as the variation.
so the demands for food and footwear are ine-
percentage of the price. In this case, a rise in price
elastic with respect to the price. In contrast, if the disease
a 1 percent decrease causes a decrease in demand
the mad cow disease will raise the price of British beef, the
of that same percentage. Later we will see that this
people could resort to beef from other countries or lamb or
condition implies that total spending on a good (which
chicken to meet their meat needs. Therefore, the
they are equal to P×Q) are constants even when varying
British beef has a high price elasticity.
the price.
The time it takes for consumers to respond to the
price variations also play a role in To show how elasticities are calculated, examine-
important. A good example is gasoline. Let’s suppose that the simple case of the response to the purchases to a su-
we are traveling across the country and suddenly the price goes up bid of a price represented in Figure 4-1. In the situation-
from the gasoline. Is it likely that we will sell the car and initially, the price was 90 and the quantity demanded of
Do we consider the holidays over? No. Therefore, to 240 units. The price increase to 110 led to the consumers-
In the short term, the demand for gasoline can be very inelastic. midores to reduce their purchases to 160 units. In the Fig-
However, in the long term we can adapt our con- ra 4-1, they were initially at point A, but
due to the increase in gasoline prices. We can buy moved along their demand curve until the
a smaller car that consumes less gasoline, to go puntoBal increase the price.
by bike or by train, moving to a place closer to the Table 4-1 shows how the price elasticity is calculated.
work or come to an agreement with other people to com- The price increase is 20 percent and the decrease
to leave the car. The possibility of adjusting the patterns of resulting quantity is 40 percent. Clearly, the
consumption implies that the elasticities of general demand price elasticity of demand isED= 40/20 = 2. It is ma-
they are usually greater in the long term than in the short term. I believe that it shows an elastic demand well.
regarding the price in the segment between A
Economic factors determine the magnitude of
yB.
price elasticities of goods: elasticity
In practice, it is somewhat complicated to calculate the elasticities.
tends to be higher in the case of luxury goods,
when there are substitutes and when they are consumed Thus, we emphasize three key steps in the
They have more time to adapt their behavior. that the reader must be especially careful. Remember, in
first place, we remove the negative signs and consi-
let's assume, then, that all percentage variations are
How are elasticities calculated? positive. That means that all elasticities are wr
I see positive numbers, even when the prices and the
If we can observe how much the quantity demanded varies demanded quantities vary in the opposite direction due to
when the price varies, we can calculate elasticity. The the law of diminishing demand.
 APPLICATIONS OF SUPPLY AND DEMAND 59

the difference is significant. To avoid ambiguities, always-

P we take the average price as the base price for calculation
200 the price variations. In Table 4-1, we have used
180
in the elasticity formula, the average of the two prices
[P= (90 + 110)/2 = 100] as the base denominator. For
160
to measure the percentage variation of the amount, we have used
140 as a base the average amount [Q = (160 + 240)/2 = 200]. The
120 P2 D B the exact formula to calculate elasticity is, then:
100 A
80
⌬Q ⌬P
P1 D ED= ÷
60 (Q1+Q2) / 2 (P1+P2) / 2
40 whereP1yQ1they represent the initial price and quantity and
20 P2yQ2the new price and the new quantity.
Q2 Q1
0 Q
0 40 80 120 160 200 240 280 320 360
Quantity Graphical representation of price elasticity

Figure 4-1. ELASTIC DEMAND SHOWS A It is also possible to graphically determine the elasticities.
GREAT RESPONSE OF QUANTITY TO A VARIATION Price. Figure 4-2 shows the three cases of elasticities.
OF THE PRICE. The market is initially in equilibrium In all of them, the price drops to half and consumers
brio at point A. By increasing the price by 20 percent, the quantity-
the demanded quantity changes, shifting from AaB.
dad demand decreases by 40 percent until point B.
Price elasticity is ED= 40/20 = 2. Therefore, the demand
In Figure 4-2(a), the price reduction by half has
it is elastic in the segment between A and B. that the demanded quantity triples. This case shows
tra, just like the example in Figure 4-1, the elastic demand
dynamic regarding the price.
In Figure 4-2(c), the price is halved.
Secondly, note that in the definition of the only causes an increase in the quantity demanded of 50
Elasticity uses the percentage variations of the price. by 100, so this is the case of inelastic demand
and from the demand instead of the absolute variations. That regarding the price. Figure 4-2(b) shows the limiting case
it means that a variation in the units of measurement does not gives the unit elasticity demand, in which it duplicates
affects elasticity. Therefore, price elasticity does not go- the change in the quantity demanded exactly offsets the re-
, regardless of whether we express the price in cents- reduction of the price by half.
or in dollars. Figure 4-3 shows the important opposites in
The third observation refers to the exact procedure. those whose price elasticities are infinite and
what is used to calculate the percentage variations of the zero, that is, the demand is completely elastic and totally
price and quantity. The formula for a variation by- inelastic. The second, that is, the demand whose elasticity
centual is⌬ P/P. The value of⌬ Table 4-1 is clearly it is zero, it is the one in which the quantity demanded does not res-
20 = 110 - 90. But it is not immediately clear what the responds to changes in price; this type of demand is
value that we should use for the denominator. Is it the represented by means of a vertical demand curve. In
initial value of 90? The final value of 110? Or an intermediate value? change, when demand is infinitely elastic, a pe-
half? a tiny variation in price causes a huge variation in
When the percentage changes are very small, give me the quantity demanded, as shown by the curve of
for example, from 100 to 99, it doesn't matter much what we use horizontal command of Figure 4-3.
99 or 100 in the denominator. But when they are large, the

Table 4-1. EXAMPLE OF A GOOD WHOSE DEMAND IS

ELASTIC. Let's consider the situation where the price su- Elasticity is not the same as slope
from 90 to 110. According to the demand curve, the can-
the demanded quantity decreases from 240 to 160. The price elasticity- We must always remember that we should not confuse the
that is the quotient between the percentage variation of the quantity elasticity of a curve with its slope. This distinction is
and the percentage change in price. We remove the negative sign. it is easily seen when examining the demand curves in
negative so that all elasticities are positive. straight line shape that is often found in examples.
Demand curves are usually represented in the form of lines.
a straight line because they are easy to draw. It is logical, therefore, to pre-
Caso A:Precio = 90 y cantidad = 240
to ask what the price elasticity of a demand curve is
Caso B:Precio = 110 y cantidad = 160 in a straight line.
This question has a surprising answer. Throughout
Percentage variation of the price=⌬ P/P = 20/100 = 20% from a linear demand curve, the elasticity-
Percentage variation of the quantity=⌬ Q/Q = -80/200 = -40% dad-price varies from zero to infinity! Table 4-2 provides a deta-
a series of calculations of elasticity performed with it
Price elasticity = ED= 40/20 = 2 technique that in Table 4-1. This table shows that the curves
60 ECONOMY

(a) Elastic demand (b) Demand of unit elasticity inelastic demand

P D P D P D
A A
1.000 1.0 4 A

B B
500 0.50 2 B
D
D
1
D
Q Q Q
0 1 2 3 0 1.000 2.000 0 5 10 15 20
Quantity (millions) Quantity (millions) Quantity (millions)

Figure 4-2. PRICE ELASTICITY OF DEMAND IS DIVIDED INTO THREE CATEGORIES.

linear demand starts with a high elasticity

In summary, although the extreme cases of total demand-
price, being the price high and the quantity small and they end up elastic and totally inelastic can be deduced from
with low elasticity, where the price is low and the quantity the slopes of the demand curves only, in the
big. intermediate cases, which correspond to almost all goods,
This fact shows an important issue. When do... elasticities cannot be deduced merely from the pen-
we serve a demand curve on a graph, generally tooth. (See Fig. 4-5 for a way to calculate the
It is not true that if its slope is steep, the demand is elasticity in a graph.
inelastic and that if it is flat, the demand is elastic. The pen-
slope is not the same as elasticity, since the slope
the demand curve depends on the variations of Py A method to calculate [Link] calc-
Q, while elasticity depends on its variations by- to calculate the price elasticity of a demand curve we can
century. The only exceptions are in extreme cases. use a simple rule: the elasticity of a straight line
of completely elastic and completely inelastic demands. at a point it is the quotient of the length of the segment if-
Let's examine Figure 4-2(b) to see the difference. It is obvious.
since this demand curve is not a straight line
constant slope. However, it has an elasticity of the
constant demand for ED= 1 because the percentage change
the price is the same at all points as the percentage variation
P
actual of the amount. Remember, then, that elasticity is
clearly different from the slope.
200 D
Demand
perfectly
inelastic
150
Figure 4-4 illustrates the mistake made when you...
merge the slope with elasticity. This figure represents a
demand curve in the form of a straight line. Since it is linear, it has Of D’
100
not the same slope at all points, but at the end Demand
superior, close to A, the percentage variation of the price is very perfectly
small and the percentage variation of the quantity is very large elastic
50
therefore, the elasticity is extremely high. Therefore, the
price elasticity is relatively high when we find ourselves
segments at the top of the linear curve DD. Instead, D
Q
when we find ourselves at the bottom of the curve of 0 100 200 300
linear demand, price elasticity is less than one. Near the Quantity
On the x-axis, the price elasticity is close to zero.
Figure 4-3. PERFECTLY ELASTIC DEMAND AND
In more general terms, above the point PERFECTLY INELASTIC DEMAND. The extremes
Halfway of any straight line, the demand is elastic. The opposites of demand are the vertical demand curves.
tica, beingED1. At the midpoint, it is elastic- the ones that represent a perfectly inelastic demand
unitary dad, being ED= 1 y, por debajo, es inelástica, (ED= 0), and the horizontal demand curves, which represent
beingD< 1. a perfectly elastic demand (ED. =D).
 APPLICATIONS OF SUPPLY AND DEMAND 61

Table 4-2. CALCULATION OF PRICE ELASTICITY ALONG A LINEAR DEMAND CURVE.⌬ Present the va-
price variation, that is,⌬ P=P2–P1, while⌬ Q=Q2–Q1To calculate numerical elasticity, the percentage change
the price is equal to the variation of the price⌬ Divided by the average price [(P2+P1the percentage variation of production
it is calculated by dividing⌬ For the average price [(Q2+Q1)/2]. Considerando todas estas cifras como números positivos, el cocien-
the resulting gives us the numerical price elasticity of demand, EDNote that in the case of a straight line, the elasticity-
it is tall at the upper end, short at the lower end, and exactly 1 at the midpoint.

NUMERICAL CALCULATION OF THE ELASTICITY COEFFICIENT

Q1+Q2 P1+P2 SQ SP
Q SQ P SP ED= ÷
2 2 (Q1 +Q2) / 2 (P1+P2) / 2

10 2
0 6 ÷ =5 (elastic)
5 5
10 2 5 5

10 4
10 2
10 2 15 3 ÷ 1 unit elasticity
15 3
20 2
10 2
10 2 25 1 ÷ =0.2 (inelastic)
25 1
30 0

located below the point and the length of the segment situates the one above (AM) and the one in the segment located below
of above. (MZ) is exactly the same, so the elasticity is
To see it, let's first examine Figure 4-4. Observe- MZ/AM= 1. At point B, this formula indicates that ED=
I know that at the midpoint M, the length of the segment is situated- =BZ/AB=3/1= 3; at the point R, ED= 1/3.
Knowing how it is calculatedDin a straight line, we can
calculate the EDcorresponding to any point on a curve
of demand in the form of a curve, as shown in Figure-
4-5. 1) Draw the tangent to the curve with a ruler at its
Elasticity of a straight line point (for example, in B, in Figure 4-5) and 2) calculate the
P EDcorresponding to the straight line at that point (e.g., at
B= 3). The result will be the correct elasticity of the curve at
D
4 the pointB.
A
ED1
3
B
P
ED= 1 A
4 D
2
M B
3
ED< 1
2
1 D
R
1
Z D Z
Q Q
0 1 2 3 4 0 1 2 3 4

Figure 4-4. THE SLOPE AND ELASTICITY ARE NOT THE SAME Figure 4-5. A SIMPLE RULE FOR CALCULATING THE
MISMO. All points of the demand curve in shape DEMAND ELASTICITY. To calculate the elasticity
Straight lines have the same slope, but above from the demand we take the quotient between the length of the
from the midpoint, the demand is elastic; below, it is inelastic segment of the line situated below the point and the longi-
elastic; at the midpoint, it has unit elasticity. The elas- all of the segment located above the point. Thus, for
Price elasticity can only be deduced from the slope. For example, at point B we can calculate that the elasticity
in the case of the vertical or horizontal curves shown It is 3. When the demand curves are not linear, it is enough
in Figure 4-3. trace the tangent and calculate its elasticity.
62 ECONOMY

ELASTICITY AND INCOME they are unforeseen displacements to resolve a cri-

unexpected demand (another case of inelastic demand with respect to
Many companies want to know if a price increase at the price). Airlines have developed highly complex
will raise or reduce its income. This issue has a im- software programs to manage the number of places
strategic importance for companies such as airlines, in order to ensure that its passengers who have a low
the restaurants and the magazines, which must find out if it is worth elasticity cannot benefit from lower rates.
the penalty of not raising prices and whether the increase is worth it or not As a consequence, their benefits have continued to be
reduction of demand. Let's examine the relationship between the high while they filled their planes with paying passengers
price elasticity and total revenue. economic rates.
Total income, by definition, the price multiplied
for the quantity (that is, P×Q). If consumers buy 5
Units at $3 each, the total income is $15. If the le...
you know the price elasticity of demand, you know what to do
It will affect the total income when the price varies: The paradox of the abundant harvest

1. When demand is inelastic with respect to price, Elasticities can be used to show one of the
a decrease in the latter reduces total income. the most famous paradoxes of all economics: the paradox of the
2. When demand is elastic with respect to price, a abundant harvest. Let's imagine that one year nature
decrease of this last one raises total income. smile at agriculture. A cold winter destroys the pests;
In the limit case of unit elasticity demand, spring begins soon for sowing; there are no devas-
a decrease in price does not alter total income. frozen shoots; the rain nourishes the buds that are growing
and a sunny October allows it to reach the market a
For example, the demand for air transport from people- abundant harvest. At the end of the year, the Jiménez family
those traveling for business purposes is inelastic, therefore happily prepares to calculate the rent for the year and finds himself with
that an increase in first-class fares tends to ele- a huge surprise: the good weather and the abundant harvest
there is income. In contrast, the demand for air transport they have reduced their income and that of other farmers.
People who travel for leisure purposes are much more. ¿Cómo es posible? La respuesta se halla en la elasticidad
elastic, as they have many more opportunities to choose the of the demand for food products. The demands of
place and the date when they are going to travel. Therefore, the increase in the basic food products like wheat and corn have
tourist rates tend to reduce income. to be inelastic; the consumption of these necessary goods
it only varies in response to the price. But that means that the
farmers overall receive a lower total income
when the harvest is good than when it is bad. The increase
from the supply derived from an abundant harvest tends to reduce
Above the financial skies raise the price. But the price reduction does not raise much the
with "elastic airlines" demand quantity. Therefore, when the price elasticity
of food is low, a great harvest (a high value
For the airlines in the United States, it's worth billions of
tends to be accompanied by a low income (a low va-
dollars understand the elasticities of demand.
Ideally, they would like to charge a relatively high price to
lor deP×Q).
people who travel for business reasons and one suf... These ideas can be illustrated by returning to Figure 4-2.
recently lowered to those traveling for leisure reasons, with We begin by showing how income is measured in the pro-
the end of occupying all the vacant spots. It is a str chart. Total income is the price multiplied by the
strategy to increase income and maximize profits. quantity, P×Q. On the other hand, the area of a rectangle
But airlines have a big problem if they charge. it is always equal to its base multiplied by its height. For so-
a price for passengers traveling for business purposes to, the total income corresponding to any point of a
and that have low elasticity and another lower to which The demand curve can be found by examining the area of the rec-
They travel for pleasure and have a high elasticity: triangle formed by the Py the Q at that point.
keep the two classes of passengers separate. How can
Next, we can verify the relationship between the
to prevent the first ones from acquiring the cheap tickets
destined for the seconds without preventing the seconds from occupying elasticity and income in the case of unit elasticity of the
Are there pens that the first ones would be willing to buy? Figure 4-2(b). Note that the shaded area corresponds to
Airlines have resolved the problem by practicing the revenue at entry (P×Q) amounts to 1.000 billion dollars
price discrimination to be able to exploit the differences both at point A and at point B. The shaded areas
price elasticities. Price discrimination with- the total income they represent are equal because the
to charge different prices to the various clients for variations of the base of Qy of the height of Pse contrarres-
the same service. Airlines offer lower fares tan. It is what would be expected in the limiting case of the demand-
to the passengers who plan their trips in advance and who have of unit elasticity.
of remaining longer. One way to separate the We also observe that Figure 4-2(a) corresponds to
two groups is to offer lower rates to people who
the elastic demand. In this figure, the rectangle that represents
they remain on Saturday night, which deters the hom-
businessmen who want to return home for the weekend. the income increases, going from 1,000 million dollars-
In addition, it is generally not possible to get a rate. it brings down to 1,500 when the price is halved. Given that
lower at the last minute because many business trips total income increases when the price is decreased, the de-
the sleeve is elastic.
 APPLICATIONS OF SUPPLY AND DEMAND 63

In Figure 4-2(c), the rectangle representing the input sensitivity of the quantity supplied of a good to its price
it reduces from 40 million dollars to 30 when it goes down the market.
price at half, so the demand is inelastic.
Which of these diagrams illustrates the case of agriculture, More specifically, the price elasticity of supply
in which an abundant harvest reduces total income it is the percentage variation of the quantity offered divided
of the farmers? Clearly, Figure 4-2(c). What re- given by the percentage variation of the price.
presents the case of vacation trips, in which a re-
Could a price reduction mean an increase in income? Just as happens with demand elasticities,
Certainly, Figure 4-2(a). There are extreme cases, in which the elasticities of the supply...
Your son has ups and downs. Let's suppose that the offered amount is
Table 4-3 shows the main points that must be
to remember about price elasticities. totally fixed, as in the case of perishable fish that
is taken to the market daily and sold at the price that
can be reached. This is the limit case of zero elasticity, or
sea, from the totally inelastic supply, which is a curve of
vertical offer.
The taxes on cigarettes Let's assume, on the other end, that a minimal reduc-
and tobacco consumption the price reduction to zero the quantity offered and that a
a minimal price increase attracts an infinitely large supply
How do cigarette taxes affect consumption? of. In this case, the quotient between the percentage change of
my tobacco? Some people say that tobacco is so the quantity offered and the percentage variation of the price is
addictive that people pay anything to have their cigarettes
extraordinarily large and gives rise to a supply curve
Daily. Economists examine the price elasticity of the
horizontal. This is the extreme case of the infinitely increasing supply.
demand to answer this question.
An interesting experiment was conducted in New Jersey. elastic.
doubling the tax on cigarettes in 1998, that is, Between these extremes, we say that the supply is elastic or
raising it from 40 cents per package to 80. This increase of inelastic, depending on the percentage variation of the
tax raised the average price of cigarettes from $2.40 to amount is greater or less than the percentage change of the
2.80 $ per package. Economists estimate that once you- price. In the limiting case of unit elasticity, in which
considering the trends in consumption and sales of the price elasticity of supply is equal to 1, the increase in-
In neighboring states, tobacco consumption decreased from 52 the percentage of the amount offered is exactly equal to the su-
millions of packages at 47.5 million. bid percentage of the price.
Using the elasticity formula, we can calculate
It is easy to see that the definitions of the elasticities pre-
that the short-term elasticity is 0.59 (the reader should ensure)
that gets the same figure). There are similar estimates.
the terms of the offer are exactly the same as those of the elastic-
coming from more detailed statistical studies. The cities-price of the demand. The only difference lies in
data indicate, then, that the demand for cigarettes is inelastic that, in the case of the offer, the response of the quantity to the pre-
in the short term, but which clearly responds to its prices. The supply is positive, while that of the demand is negative.

The exact definition of the price elasticity of supply.

ta,ES, it is as follows:

PRICE ELASTICITY OF SUPPLY Percentage variation of the quantity supplied

ES =
Percentage variation of the price
Naturally, consumption is not the only thing that varies when
prices rise or fall. Companies also respond Figure 4-6 represents three important cases of the elas-
at the price when they decide the quantity they are going to produce. Se- elasticity of supply: a) the vertical supply curve in which the
According to economists, the price elasticity of supply is the the supply is completely inelastic; c) the horizon supply curve

Table 4-3. ELASTICITIES: SUMMARY OF THE FUNDAMENTAL CONCEPTS

Value of elasticity
from the demand Description Definition Influence on income

Greater than one (ED1) Elastic demand Percentagevariationofthequantity Income increases when
demand and variation the price drops
percentage of the price
Equal to one (ED= 1) Demand elasticity Percentagevariationofthequantity The income does not vary when
unitary demand is equal to the variation the price goes down
percentage of the price
Less than one (ED< 1) Inelastic demand Percentagevariationofthequantity Income decreases when
demand for men than the variation the price drops
percentage of the price
 APPLICATIONS OF SUPPLY AND DEMAND 65

2.4

2.0
Agricultural prices divided by
the consumer price index

1.6

Figure 4-7. THE PRICES OF

AGRICULTURAL PRODUCTS
BASICS HAVE DECREASED 1,2
VERTIGINOUSLY. One of
the main factors that have
influenced in the United States has been
of the continuous decline of the Descendant line
agricultural product prices 2% per year
the basics, such as wheat, corn,
soy, etc. During the second 0.8
mid-century XXthe prices
agricultural decreased by 2 percent
100 a year in relation to the level
general price index. Note the
registered temporary investment du-
face the shortage of products 1950 1960 1970 1980 1990 2000
psychos of the seventies. (Fuen-
Bureau of Labor Statistics.

What happens to the offer? Although many people believe

P
mistakenly that agriculture is a backward sector,
Statistical studies show that productivity (the pro-
D D. S
(unit factor reduction) has grown faster in this
S. sector that in almost all others. Among the important advances-
many are found the mechanization through tractors,
cotton harvesters and pickers; fertilization and the
irrigation; selective cultivation and the development of modified crops
genetically modified. All these innovations have increased
E extraordinarily increasing the productivity of the factors
agricultural. The rapid growth of productivity has raised
give the extraordinarily offer, as shown by the displacement-
shifting of the supply curve.S. in Figure 4-8.
What should happen in the new competitive equilibrium?
The huge increases in supply are higher than the mo-
of these increases in demand, which produces a tendency
S E. downward trend in agricultural prices in relation to others
prices of the economy. And that is precisely what has happened.
S. D D. has occurred in recent decades, as shown in Figure 4-7.
Q
Quantity Limitation of cultivated [Link] the face of the dis-
reduction of rents, farmers have frequently turned to
fearing the governments in search of economic help. To the
Figure 4-8. AN INCREASE IN SUPPLY AND A DEMAND- Over the years, the governments of many countries have taken
THE INELASTICITY REGARDING PRICE CAUSES of numerous measures to help them. They have taken the steps
DISCONTENT IN AGRICULTURE. The balance, which is in- necessary to keep prices high; have reduced
It is found at point E, representing the existing situation in the
imports through tariffs and quotas; and to see-
agricultural sector several decades ago. The demand for products
agricultural land tends to grow at a much slower rate than
they have simply sent a check to the farmers
that they have accepted not to cultivate their land.
the enormous increase in supply generated by progress
technological. Therefore, competitive agricultural prices The paradox of the abundant harvest has an interesting
they tend to decrease. On the other hand, being inelastic the demand application in this case. Many governments try to help
regarding the price, agricultural rents decrease with- farmers reducing their production. How can be-
the form increases the income. will that benefit farmers? Figure 4-9 shows the analysis-
66 ECONOMY

Let's examine, for example, the case of a tax.

P D about gasoline in order to show how the im-
S. S set to production and the market price. Although in
United States politicians periodically complain about the
After the limitation gasoline taxes, these are much lower in
of the extensions United States, where they revolve around 50 cents, which in
cultivated
almost all European countries, where they range between 2 and 5 $
B E.
per gallon. Many economists and environmentalists are in favor of
that gasoline taxes are much higher
in the United States. They point out that higher taxes
would curb consumption and, therefore, would reduce pollution.
A
E tion and the country's dependence on insecure sources ex-
Before the limitation oil tankers. In 1999-2000, there was again an insistence on
of the extensions the need to reduce energy consumption, especially
cultivated of oil, when prices skyrocketed.
Let's assume to be concrete that the government decides to reduce
D establishing incentives to consume oil
S
S. X $1 tax per gallon on gasoline. The legislators
Q
0 prudent people would certainly be reluctant to rise so much
Quantity the taxes on gasoline without fully understanding
the consequences of that measure. They would like to know what the
Figure 4-9. THE LIMITATION PROGRAMS OF THE EX- impact of the tax. By impact we understand the re-
CROP TENSION RAISES THE PRICE SO MUCH last economic impact of a tax on incomes
LIKE AGRICULTURAL RENT. Before the limitation of the realities of producers or consumers. The fact that
cultivated extensions, the competitive market produces a that companies issue a check to the State for the im-
equilibrium at a low price in E. When the government limits- Positions do not mean that they actually reduce their benefits.
in production, the supply curve shifts to the left Using supply and demand, we can know who
left aS.S ., so the equilibrium is shifted to E. and the
truly bears the tax burden, that is, what is its
Price rises to AB. Confirm the reader that the new rectangle
of the income 0BE.S . is greater than the initial 0AEX: the in-
incidence.
growth is greater as a consequence of the inelasticity of the It may happen that your load is moved forward to the
demand. consumers, if the retail price goes up in the same
my amount that the tax, that is, 1 $. It can also
to occur that consumers reduce their purchases of
Economic analysis of this policy. If the Ministry of Agriculture- gasoline for the tax burden to be fully transferred to
tura forces all farmers to reduce their production, CIA behind oil companies. It is only possible to damage...
the supply curve shifts upwards and towards guarantee on whom the tax falls between these extremes reali-
the left. As food demands are inelastic- making an analysis based on supply and demand.
These limitations not only raise the price of cultivation. Figure 4-10 gives us the answer. It shows that the equili-
initial profit before tax is found in E, which is the
you, but they also tend to raise total income of
point of intersection of the initial curves SS and DD, with a
the farmers. In the same way as the good harvests-
harms the farmers, the limitation of the exten- price of gasoline at $1 per gallon and an annual consumption of
Cultivated lands tend to raise agricultural incomes. such as 100 billion gallons. The establishment of a
Naturally, the limitation of the cultivated areas $1 tax in the retail gasoline market is re-
and the rise in prices harms consumers, what presents through an upward movement of the
the same thing that would happen if a flood or a drought caused a supply curve, without the demand curve changing. This does not
food scarcity. moves, because after the increase in the gasoline tax
Production restrictions are a typical case of No, the quantity demanded at each of the selling prices.
state interference in the market that raises the the public does not vary. Note that the demand curve of
rental of one group at the expense of others. In later chapters gasoline is relatively inelastic.
we will see that this type of policy is inefficient: what they gain In contrast, the supply curve does shift clearly in
the losses for farmers are, in fact, less than what they lose upward trend at $1, as producers are only
consumers. willing to sell a certain quantity (e.g., 100,000
millions of gallons) if they perceive the same price.
before. That is to say, for each offered amount, the price of mer-
THE INFLUENCE OF TAXES The drop must rise exactly in the amount of the tax. If
IN THE PRICE AND IN THE QUANTITY the producers were initially willing to sell
80 billion gallons at $0.90 per gallon would still be
The State imposes taxes on a wide variety of I am willing to sell the same amount for $1.90.
goods: cigarettes and alcohol, payrolls and benefits once the tax is deducted, it reports the same $0.90
cios. The supply and demand-based analysis can help per gallon.
give us to predict who will bear the true burden of a What will the new equilibrium price be? The answer is
tax and how it will affect production. find at the intersection of the new supply and demand curves
 APPLICATIONS OF SUPPLY AND DEMAND 67

how taxes or tariffs on imports affect me

P actions on foreign trade; and how taxes affect
D about real estate, social security contributions
S.
and the taxes on corporate profits to the
E.
2.0 land prices, wages, and interest rates.
1.00 The key issue in determining the impact of a...
S. the relative elasticities of supply and of
1.5
0.90 Send. If the demand is inelastic in relation to the supply,
S
as is the case with gasoline, most of the cos-
1.0 it is passed on to consumers. In contrast, if the supply is
0.10
inelastic in relation to demand, as in the case of the
S
0.5 land, most of the tax is shifted to the suppliers.
Here is the general rule for determining the incidence of a
D
tax
Q
0 50 100 150
The incidence of a tax refers to the impact of
Amount (thousands of millions of gallons) session of the tax on producers' incomes and
of consumers. In general, the incidence depends on
of the relative elasticities of demand and of the
Figure 4-10. A GASOLINE TAX FALLS offer. A tax is passed forward to the
BOTH IN THE CONSUMER AND IN THE PRODUCER. consumers if the demand is inelastic in relation
What is the incidence of a tax? A tax of $1 with the offer; it shifts backwards to the producers
about gasoline shifts the initial supply curve if the supply is relatively more inelastic than the
ascending sense and in parallel in the same amount until demand.
S .S .This new supply curve intersects at the new point.
to equilibrium, E., in which the price that consumers pay
the mid-price has risen 90 cents and what producers receive
MINIMUM AND MAXIMUM PRICES
stores have dropped by 10 cents. The blue arrows
they show the variations of PyQ. Note that the consu-
Mediators bear the majority of the tax burden. Sometimes governments set a maximum price by law.
maximum or one minimum instead of taxing or subsidizing a
Good. The history is full of examples. Since biblical times-
public, governments have limited the interest rates that
send, that is, at point [Link] which they are cut.S. y lenders can charge (the so-called laws on the
DD. As a consequence of the shift in supply, the usury). In times of war, governments often control
the price is higher and the quantity offered and demanded is me- wages and prices to prevent an inflationary spiral
nor. If we examine the graph closely, we will see that the During the energy crisis of the seventies, in This-
the new equilibrium price has risen from 1 to 1.90 $ approximately In the United States, gasoline prices were controlled. Current-
damente. El nuevo nivel de producción de equilibrio, en el mind, there are increasingly strict limitations on
that supply and demand are in equilibrium, has descended- the prices that doctors or hospitals can charge and
from 100 billion gallons to about 80 billion. some major cities, including New
Who ultimately pays the tax? What is its York controls the rental prices of the apartments.2. The pro-
incidence? Evidently, the oil industry pays proposals to raise the minimum wage are among the
a small part, as it only perceives 90 cents ($1.90 - $1) most controversial issues of economic policy.
of tax) instead of $1. But the consumer bears the These types of interferences in the laws of supply and
majority of the burden, since the retail price demands are really different from those in which the
It rises by 90 cents, due to the fact that the offer is relatively The state imposes a tax and lets the market act.
elastic with respect to price, while the demand is through supply and demand. Although there are always
relatively inelastic. political pressure to keep prices low and
high salaries, experience has taught us that those with-
The [Link] taxes are used to discourage sectoral roles of prices and wages tend to
to tell individuals to consume a good, the subsidies are to cause major economic distortions. However, co-
they are used to promote production. There is a widespread Adam Smith knew very well when he protested against the policy
example of a grant in agriculture. The influence of the mercantilist of the previous era, most of the systems
subsidies in a market can be examined by displacing economics are full of inefficiencies that are due to in-
in descending order of the supply curve. The rules ge- well-intentioned but inexperienced interferences in the meca-
The details of the grants are exactly parallel to the mechanisms of supply and demand. The setting of a price
of taxes. maximum or a minimum price in a market tends to pro-
invoke some surprising economic effects and, on occasion-
General rules on tax transfer. yes, pathological. Let's see why.
Gasoline is just an example of how it is analyzed
translation of taxes. Using this instrument po-
Let's understand how taxes affect the ta- 2
See Discussion Topic 9 of this chapter to examine the control.
it affects both prices and cigarette consumption; it- of the rentals.
68 ECONOMY

Two important examples of state intervention are

D
the minimum wage and the control of gasoline prices. S
They show the surprising side effects that can
to occur when the State interferes in the determination
of the price and the quantity based on the market. Wminute
E U
LF

The controversy over the minimum wage

The minimum wage sets the minimum amount that can be paid. Wmarket M
the entrepreneurs to the workers. In the United States, the sa- S
lario mínimo federal se estableció en 1938, cuando el gobier-
he did not force the workers covered by the industries to pay
D
three covers at least 25 cents per hour. At that time,
the minimum wage represented around 40 percent Unskilled work
of the average industrial wage. The minimum wage increased from
from time to time and in 1996 it was $4.25 per hour, which repre- Figure 4-11. EFFECTS OF A MINIMUM WAGE. Setting
It only accounted for 33 percent of the average industrial salary. of a minimum wage in Wmine, superior to the equilibrium of li-
As it had decreased in relation to average income, bre marketWmarket, it provokes a balance inE. Employment
in 1999 President Clinton proposed and Congress approved decreases, as shown by the arrows, fromMaE. The unem-
a raise to $5.15 per hour. What is the difference between the job offered in LF?
and employment in E. If the demand curve is inelastic, a
This issue divides even the most eminent economists. Increase in the minimum wage raises the income of workers
nents. For example, Nobel Prize winner Gary Becker has stated- of low wages. To see it, shade the rectangle of the
I said emphatically: 'Raise the minimum wage, and you will leave the ... total salaries before and after the salary increase
"people without jobs." Another group of award-winning economists nimo.
with the Nobel Prize has responded: "We believe that the salary
The federal minimum can be raised moderately without putting mu-
"puts the job opportunities at risk." Another prominent
economist, Alan Blinder, professor at the University of the offered quantity and the demanded quantity is indicated by U, which
Princeton and former economic advisor to President Clin- it represents the amount of unemployment.
ton has written the following: Using supply and demand, we observe that it is pro-
It is likely that unemployment will increase and employment will decrease.
People earning the lowest wages have been suffering for years. of low-skilled workers. But how large are the-
He/She needs all the help he/she can get and he/she needs it. how will these magnitudes be measured? And how will they affect salary income?
quickly. Around 40 percent of all salaried workers of low-income workers? To examine these issues
those who receive the minimum wage are the only ones who receive a
In actions, we can observe the empirical evidence.
salary at home and around two thirds of adolescents
those who earn the minimum wage live in households whose income is Most studies indicate that a rise in sa-
a minimum wage decrease of 10 percent would reduce employment of the
below average. Honestly, I don't know if a small increase
adolescents between 1 and 3 percent. The influence on the em-
whether the minimum wage would reduce employment or not. If it does reduce, the
the effect is probably very small. the workload of adults is even lower. According to some studies
May 1996. recent effects are almost null and others suggest that the
employment could even increase. A close reading of the quotes
How can laypeople examine the issues? of the prominent economists indicates, then, that some eco-
when the experts are so divided? How can we nominists consider that small means 'insignificant'
clarify these apparently contradictory statements? while others emphasize that it is lost, upon the
To begin with, we must acknowledge that the claims about us, some job. Our example in Figure 4-11 shows
the convenience of raising the minimum wage contains judgmentstranslate a case in which the decrease in employment (represented
of personal value. Those statements could be based on the due to the difference between MyE) is very small, while
better positive economy and, nonetheless, make recommendations unemployment caused by the minimum wage (represented
different important issues related to the by the straight line U) is relatively large.
economic policy. Another factor of the debate is the influence of the minimum wage.
A cold analysis indicates that the debate about the minimum wage in the rent. Almost all studies come to the conclusion that
my gira mainly revolves around issues of interpretation that the demand for low-wage workers is inelastic
more to fundamental discrepancies about the resu- regarding the price. The results we just mentioned
empirical data. Let's start by examining Figure 4-11, indicates that the price elasticity ranges between 0.1 and 0.3. That
what does the market for unskilled workers represent. leads to the surprising conclusion that an increase in the room-
The figure shows that the minimum wage sets a ceiling. The minimum wage would raise the income of low-income workers.
minimum for most jobs. When as a whole. Given the elasticities we just mentioned,
rises above the equilibrium that empties the situated market a 10 percent increase in the minimum wage would raise between
en el puntoM, el número total de puestos de trabajo se des- a 7 and a 9 percent the income of the affected groups. The Figu-
square in an ascending direction along the demand curve Table 4-11 shows how the wages of the workers increase
from aE, which is why employment decreases. The difference between therent is low despite the decrease in total employment. It can
 APPLICATIONS OF SUPPLY AND DEMAND 69

verse comparing the rent rectangles located below

of the equilibrium points EyM. (See the discussion topic P
session 8 that is found at the end of this chapter. 3 D. D S
The influence on income is another reason why it can
there are discrepancies about the minimum wage. People are
those who are particularly concerned about the well-being of the groups
2 E Level of balance
those with low income may think that a small inefficiency is without maximum price
a low price if what is achieved is an increase in ren-
Others - those who are more concerned about costs accumulate-
C J K
two of the interferences in the market or the influence of the 1 Maximum price
2
increase in costs in prices, in profits and in
international competitiveness— they can argue that the ine- Supply shortage
efficiency is a price too high. Others may believe that S D. D
at the maximum price

the minimum wage is an inefficient way to transfer po- Q

the purchasing power to low-income groups; they would prefer to use 0
direct rent transfers or wage subsidies Quantity (billions of gallons)
public policies are ruining the salary system. To what extent are they
important for the reader each of these three concerns
depending on their priorities, it could extract conclusions. Figure 4-12. PRICE CONTROLS PROVO-
IT IS SCARCITY. Without a legal price ceiling, the price would rise.
very different opinions on the advisability of raising the room-
At the maximum price of $1, supply and demand do not
minimum river. they balance and there is scarcity. A method of ra- is necessary.
mechanism, formal or informal, to allocate the scarce supply
and reduce effective demand to D.D..
The control of energy prices

Another example of state interference is one in which the

The government sets a maximum price. This is what happened in the United States. the controlled price. This difference is shown by the
United during the seventies and the results were alec- distance between JyK, which is so great that the fountains do not
founders. We return to our market analysis of ga- they take a long time to run out of gasoline. Some people have
Come to see how the maximum prices work. don't want to run out of the gasoline they want. If it were allowed to fun-
Let's set the scene. Let's assume that, as happened in If you were to let the free market operate, it would clear at a price of $2 or
1999-2000, oil prices suddenly experience more; consumers would complain, but they would be willing
a huge increase. In this case, it happened because the cartel re- to pay the highest price rather than run out of gas.
the offer and demand was increasing, but also But the market cannot be emptied, because the law prevents
it could be due to political disturbances in the Middle East producers charge a higher price. Then comes a
caused by wars or by revolutions. In Figure 3-1 I saw period of frustration and scarcity (like a kind of
the repercussions of the disturbances of 1973, 1979 and musical car game, in which a person
2000 in gasoline prices. runs out of gas when the pump runs dry). The insufficient-
Politicians, when they see a sudden rise in the pre- The gasoline supply must be rationed in some way. At the beginning-
they quickly denounce the situation. They argue that the first come, first served, limited
consumers are being "scammed" by the companies taking the amount sold to each customer into account. They are formed
benefit seekers. They fear that the rise of queues and buyers have to spend a lot of time on
prices threaten to provoke an inflationary spiral of the search for fuel.
cost of living. They are concerned about the consequences that may arise. Finally, some type of ratio mechanism is adopted.
to have for the poor and the elderly. They ask the government to naming not based on price. In the case of gasoline and
"do something." In light of rising prices, the government could for other storable goods, scarcity is usually resolved
feeling inclined to listen to these arguments and to establish a forcing people to queue, that is, rationing
maximum price for oil, as the United States did middle of the "line". Sometimes the people who have access
two between 1973 and 1981. privileged to the good are dedicated to selling it in the new market
What consequences does that price cap have? Assume- gro, that is, to carry out illegal transactions at super
more than the initial price of gasoline is $1 per gallon and compared to the regulated. There is a great waste, since the
which rises to $2 as a consequence of a radical reduction People waste valuable time trying to secure their ne-
of the oil supply. Let us now examine the market for needs. Sometimes the government conceives a more efficient system
gasoline after the disruption of supply. Figure 4-12 client based on the formal assignment or on the rationing
shows that after the disturbance, the equilibrium is found at through brochures.
the pointE. Here comes the government, which approves a law by which In the rationing system using ration cards, each
The maximum price of gasoline is set at the initial level of $1. the customer must have a booklet, in addition to money, to com-
the gallon. The straight line of Figure 4-12 represents that pre- To acquire goods, that is to say, there are actually two types of money.
maximum legal CEO. Once rationing was adopted and the ration cards distributed
At the legal maximum price, the offered quantity and the demand- According to the 'needs', scarcity disappears, already
data does not match. Consumers want to buy more that limits demand through the allocation of cards.
gasoline that producers are willing to offer How do ration cards change the landscape
70 ECONOMY

from the point of view of supply and demand? Natural- demand is high). Although it is rarely seen in most
the government must issue just enough to from the industries, they are currently expanding in the asis-
that the demand curve descends to D.D. in the Figure medical care. In the Fourth Part we will see that the controls
4-12, where the supply and new demand balance out at The prices in medicine are causing the same.
maximum price. tipos de ineficiencia que se vieron en el caso de la gasolina
The control of prices of goods such as energy, with or a few decades ago.
without formal rationing, has fallen into disgrace in the majority
of market economies. History has shown Here is an important and profound teaching: the good-
resources are always scarce. Society can never
that the legal and illegal evasion of the controls of the satisfy the desires of everyone. In the times
prices increase over time and inefficiency eventually ends Normally, the price itself rations the scarce offers.
being greater than any favorable consequence that can When the State interferes with supply and demand
and having controls for consumers. The control of Yes, prices no longer play the role of rationing.
the prices are expensive and difficult to manage, especially pains. Waste, inefficiency, and irritation are
when there are many possibilities to substitute goods sure companions of these interferences.
by others (that is, when the elasticities of supply or the

Resumen

A. The elasticity of demand and supply in luxury goods, such as snowmobiles and travel of
1. The price elasticity of demand (ED) measures the response how- vacation by plane. Other factors that affect elasticity-
quantity demanded in response to a price variation. It is found by price is the degree to which a good has easy substitutes and the
given the percentage variation of the quantity demanded by the time that consumers have to adapt to the changes
percentage variation of the price. That is to say: price actions.
[Link] price elasticity of supply measures the percentage variation
What the quantity supplied by producers experiences when
Price elasticity of demand =
The market price varies by a given percentage.

Percentagevariationofthequantitydemanded B. Aplicaciones a importantes cuestiones económicas

=ED=
Percentagevariationoftheprice [Link] of the most fruitful areas where it can be applied
analysis of supply and demand is agriculture. The improvements
In this calculation, the sign is considered positive and PyQ are the introduced in agricultural technology exceptionally raise
averages of the old values and the new ones. the offer is there, while the demand for food increases me-
[Link] elasticities are divided into three classes: a) demand us that proportionally with income. Therefore, the prices of
it is elastic when the percentage variation of the quantity demanded Food free market tends to decrease. It's not surprising.
dada is superior to the price, that is, ED1. b) The demand that governments adopt a whole variety of programs, co-
it is inelastic when the percentage change in the quantity of I limit the cultivated extensions, to maintain the
mandada is lower than the price, that is, ED1. c) The case li- agricultural rents.
percent change in the quantity demanded 8.A tax on a good shifts the equilibrium of supply and demand.
it is exactly the same as the price is the case of unidirectional elasticity demand. Its incidence (that is, its impact on incomes) re-
would be in theD 1. falls on consumers more than on producers, in the media
3. Price elasticity is a pure number, in which factors intervene. that demand is inelastic in relation to supply.
percentages; should not be confused with the slope. [Link] sometimes interfere in the functioning of the
[Link] elasticity of demand indicates how the variation of competitive markets setting maximum or minimum prices. In
total entry price. Demand is elastic if a reduction In those cases, the quantity offered does not have to be equal to that of-
the price raises total income; it is inelastic, if it reduces; in the mandate; maximum prices cause an excess of demand,
In the case of unit elasticity, a change in price does not influence. while the lows create an excess supply. Sometimes
in the total income. interference can raise the income of a group, as in the
[Link] elasticity of demand tends to be low in the case case of farmers or unskilled workers.
of necessary goods, such as food and housing, and high Distortions and inefficiencies often occur.

Review of concepts

Concepts of elasticity ED= % change of Q / % change Applications of supply and demand

deP
price elasticity of demand and of incidence of a tax
determinants of elasticity
offer distortions caused by controls
total income = P × Q
elastic demand, inelastic, of of the prices
unit elasticity rationing based on prices against
ration cards
 APPLICATIONS OF SUPPLY AND DEMAND 71

Other readings and internet addresses

Other readings Internet addresses

If the reader wants to review any particular concept, such as the There are few good directions for understanding the concepts
elasticity, you can often refer to an encyclopedia of economics fundamental economics, such as supply and demand or the
mine, like that of David W. Pearce (ed.), The MIT Dictionary of elasticities. Sometimes, the free page of the Encyclopedia Bri-
Modern Economics (MIT Press, Cambridge, MA, 1992). The enci- [Link]/contains background or mate-
the most comprehensive encyclopedia in four volumes is that of John Eatwell, historical reel. When all of that fails, one can consult the extensive
Murray Milgate and Peter Newman, The New Palgrave: A Dictionary economics [Link]/[Link]/, which is ex-
of Economics, Macmillan, London, 1987. quickly spreading and has information about many
themes.
The minimum wage has sparked a fierce debate among the
economists. A recent book by two labor economists contains Some current issues such as the minimum wage are analyzed
no evidence that the minimum wage has barely influenced employmentthey often appear in articles that appear on the Econo- page
David Card and Alan Krueger, Myth and Measurement: The New mic Policy Institute, an institution dedicated to studying issues.
Economics of the Minimum Wage (Princeton University Press, Prin- economic needs related to workers:[Link].
ceton, NJ, 1997. org/.

Discussion topics

1.A good harvest generally reduces the rent of the agrarian North American automobile companies and their work
cultivators." Explain this proposition using a graph of Some pain relievers usually defend the restriction of imports of au-
supply and demand. cars.
[Link] each of the following pairs of goods and indicate [Link] problems:
which one do you think is more elastic with respect to price and why: [Link] is estimated that global demand for crude oil has an elasticity of
fragrances and salt; penicillin and ice cream; cars and tires short-term price city of 0.05. If the initial price of
of cars; ice cream and chocolate ice cream. oil above $3 a barrel, how would it affect the price and
[Link] price drops by 1 out of 100, causing a decrease in the quantity demanded. the amount of oil an embargo that reduced supply
dada increases by 2 percent. The demand is, therefore, elastic, world oil 5 percent? Suppose in this problem-
beingEDIf 0.5 is substituted in the first sentence 2, But the oil supply curve is completely inelastic.
What other two changes need to be made in the quote? tica.
[Link] the case of a competitive housing market. [Link] show that the elasticities are independent of the
How would they affect production and the equilibrium price? units, return to Table 3-1. Calculate the elasticities in-
next changes (keeping everything else constant)? take each pair of demands. Change the dollars to cents and
Explain your answer in each case using the offer and the de- the millions of boxes per ton using the conversion
send. 10,000 boxes are equal to 1 ton. Recalculate.
a. An increase in consumer income. So the first two rows of elasticities. Explain.
b.A tax of $10 per month on rent for the vi- Why do you get the same answer.
housing. [Link] to some studies of demand, price elasticity
c. A government decree that homes cannot The demand for cocaine is 0.5. Suppose that half of
rent for more than $200 a month. New Yorkers who use this drug buy it like-
d.A new construction technique that allows building vi- committing predatory criminal acts. Show through the
homes for half the cost. analysis of supply and demand how it would affect the degree of
e.A raise in the salaries of construction workers crime in New York City a rigorous progra-
of 20 percent. law enforcement that reduces the supply of cocaine
[Link] the proposal to raise the minimum wage by 10 percent. In the New York market, 50 percent (assume in it...
After reviewing the arguments of the chapter, I estimate its impact. the exercise that the supply is totally inelastic). How
contraction in employment and in the incomes of workers affects- would affect a reduction in supply restrictions to the
Using the obtained figures, write a brief essay. criminal activities and drug use if the government
explaining the decision you would make if you had to do it it would reduce their repression efforts and that would lower the price of the
a recommendation on the minimum wage. cocaine at 50 percent? Analyze the consequences for it.
[Link] to a conservative critic of public programs, "the the price and the addiction of a program that would manage to rehab-
governments know how to do one thing well. They know how to create scarcities and to stop half of the cocaine consumers.
"excesses". Explain this quote using examples such as the sa- [Link] you explain why during a depression the livestock
minimum wage or the caps on interest rates. Show graph- they could approve a public program that would require ma-
I lie that if the demand for unskilled workers is dig up the pigs and bury them?
elastic with respect to price, a minimum wage reduces the in- [Link] the effect of the minimum wage shown in the Fig-
total income (salary multiplied by the quantity demanded- Draw the rectangles of total revenue with and without it
of those workers. minimum wage. Which is higher? Relate the effect of the sa-
[Link] what would happen if a tariff of $2,000 were established. minimum lario with the price elasticity of demand for tra-
about imported cars. Show the influence of this unskilled workers.
tariff in supply and demand and in price and quantity of [Link] one likes to pay rent. However, the scarcity of
balance of American cars. Explain why land and urban housing often causes rents to
72 ECONOMY

shoot in the cities. In response to the rise in rents city, except for a bombing, that the controls of the
laws and hostility towards landlords, the authorities sometimes rentals."Hint: What would happen to the maintenance?
rent controls are imposed. These generally limit [Link] the example of the New Jersey tobacco tax.
the increases in rents to a small internal increase draw on graph paper or on the computer
annual and can make controlled rentals very the supply and demand curves that generate prices and the
lower than those of the free market. amounts before and after tax (Fig. 4-10 shows
a. Redraw Figure 4-12 to show the effects of the example of a gasoline tax). Assume in this
control of apartment rentals. Example that the supply curve is perfectly elastic (question
[Link] will rent control affect the rate of àpar- more difficult: a demand curve whose price elasticity is
empty apartments? constant takes the form Y=AP–ewhereYes the amount of-
c. What other options could replace the rise of the al- mandada,Pes el precio,Aes una constante yees el (valor ab-
rentals? solution) of the price elasticity; find the values of Ayeque
d. Explain the words of a European critic of control they generate the correct demand curve corresponding to the
the rents: "Nothing is more efficient to destroy a prices and quantities from the New Jersey example.