Price Controls and Elasticity in Economics

Price Ceilings

Max price, illegal to charge more than price ceiling, housing market below the equilibrium price.

Inefficiencies in Price Ceiling

Shortage qd>qs, black market, dead weight loss.

Price Floor

Min price illegal to charge less than the equilibrium price, best example labor market.

Inefficiencies in Price Floor

Unemployment and dead weight loss. surplus

Consumer Surplus (CS)

The difference between what consumers are willing to pay for a good or service and what they actually pay (price paid, p*).

Producer Surplus (PS)

The difference between what producers are willing to accept for a good or service and the price they actually receive (price received, p*).

Total Surplus

The sum of consumer surplus and producer surplus.

Deadweight Loss (DWL)

The lost economic value that occurs when the market is not at equilibrium, causing fewer trades than would happen in a perfectly competitive market.

Price Elasticity of Demand

|Ed|; measures the responsiveness of Qd when the P of a good changes while everything stays constant.

Formula for Price Elasticity of Demand

ED=%△Q/%△P=(Q2-Q1)÷(Q2+Q1 ÷2)÷(P2−P1)÷(P2+P1÷2).

Elastic Graph

FLAT |Ed|>1; |%△Q|>|%△P|; a lot of substitutes, Qd is very responsive.

Unit Elastic

|Ed|=1; |%△Q|=|%△P|.

Inelastic

Steep 0<|Ed|<1; |%△Q|<|%△P|; not many substitutes, Qd is stubborn.

Perfectly Inelastic

Vertical |Ed|=0; Qd is very stubborn, no substitutes (ex: insulin).

Perfectly Elastic

Horizontal |Ed|=∞; Qd is extremely responsive, perfect substitutes, perfect competitive firm.

Income Elasticity of Demand

Eᵢ measures the responsiveness of Qd when income changes.

Formula for Income Elasticity

Ei=%△Q/%△I=(Q2-Q1)÷(Q2+Q1 ÷2)÷(I2−I1)÷(I2+I1÷2).

Normal Good

Eᵢ>0.

Necessity (Normal)

0<Ei<1

Luxury (Normal)

Eᵢ>1.

Inferior Good

Eᵢ<0.

Cross Price Elasticity

(Ex,y) or (Eqx,py) or (Ey,x); measure the responsiveness of Qd of good x when price of good y changes.

Formula for Cross Price Elasticity

ED=%△Q/%△P=(Q2-Q1)÷(Q2+Q1 ÷2) for x ÷(P2−P1)÷(P2+P1÷2) for y.

Substitutes

Ex,y>0; x,y are .

Complements

Ex,y<0; x,y are .

Unrelated Goods

Ex,y=0.

Utility

Pleasure, satisfaction max utility subject to budget constraint.

Marginal Utility (MU)

Change in total utility after a 1 unit increase in quantity of a good.

Indifference Curve

A higher indifference curve represents a higher level of utility (satisfaction).

Slope for Indifference Curve

Marginal Rate of Substitution (MRS = MUx / MUy).

Budget Constraint

A downward-sloping line showing the limits of what we can afford.

Change in Income in Budget Constraint

Parallel shift.

Change in Px or Py

Rotation.

Graphical Representation of Budget Constraint

Linear downward-sloping line.

Slope for Budget Constraint

Price Ratio (-Px/Py).

Optimal Consumer Choice

The best consumption combination occurs where the Indifference Curve and Budget Constraint are tangent.

formula for budget constraint

Y=Py​I​−Py​Px​​ times X where Y is the quantity of good Y, Py is the price of good Y, I is income, and Px is the price of good X.