So we finished up
last class talking about market
failures. So the four market failures are
this idea of market power, some monopolies,
which we will get to in a couple of
weeks, externalities, which we discussed
a fair bit, and common goods
fit into, a tragedy of the
commons fit into this idea of a negative
externality, how your use affects
third parties in a negative way. And
finally, we looked at public goods. and we'll
look at the last one in complete information
in a second. So I believe in this
class we did talk about this idea of
what we discussed in terms of the market
failure is linear public goods. The
idea where you can have like multiple
or something. So with streetlights,
you can have one, two, three all the
way up to infinity. And there's some
argument to be made that for each extra light
added, there's probably some marginal benefit
to each person. Whereas with threshold
public goods, it's either yes or no it's
binary so asteroid defense it either exists or
it doesn't or with kickstarter um you
have to raise exactly a hundred thousand dollars
and then like a board game or a video game
will be created anything less and it's not so
it's binary and in the case of threshold
public goods it's a little bit more complicated
than linear public goods this is slightly
above and beyond this course but it's
important to know that not all public goods
succumb to this idea that no matter what you
should contribute zero in the case of threshold
public goods there actually is a stable
outcome in national equilibrium as we say
that if everyone else's strategy is to pay
their equal share of the threshold public good
it's actually better for you to pay your
equal share than not pay anything at all so
when we get to game theory i'll show you
both graphically and mathematically and
intuitively why that's the case it's just something
i wanted to flag now So the final market
failure we're going to discuss,
the fourth one, is incomplete
information. So for markets to
function efficiently, this requires
participants to have reasonably good
information about prices, the quality of
the products, what technologies are
available, and the actual risks associated
with working with certain jobs or consuming
certain products. so when we say there's
incomplete information so certain market
participants don't have this information
this results in market inefficiencies so for
example in the the experiment we did in
class a week or so ago I spent the whole
hour yelling out prices and by yelling out
the prices that means everyone had complete
information about what everything was
traded out in the market without that it would
be a little bit more chaotic you wouldn't
have this information or expectation of what
it should converge to and people would
trade at all sorts of levels. So if you
remember in the first couple of rounds there's
a lot more dispersion in prices than in
the latter rounds because everyone had
complete information. So one severe source
of market failure is what we call
asymmetric information where some market
participants have much better
information about one aspect of the
market than others. And as I'll show
in the thought process, this
causes something called the unraveling
of markets. So there's a famous
paper by Akerlof called The Market
for Lemons in 1970. He actually won a Nobel
Prize in Economics for this paper and
line of work. And the funniest thing about
Akerlof, I guess, is one of the most famous
economists of all time, still alive
today, but he's not even the most famous economist
in his own family. He's married to Jeanette
Yellen, who used to be the head of
the Fed, essentially, what Powell is at the
moment. So everyone loves Jeanette Yellen,
so she's more famous than Hakoloff, even
though he has a Nobel. So he shows in this
Market for Lemons paper that this incomplete
information leads to something called adverse
selection. And we'll further go into details
when we talk about information economics
later in the semester about adverse selection.
But the basic idea is as follows. so consider
a second-hand car market so you're buying
a car off Facebook marketplace for example
and as a buyer you don't know the quality of
the car that you're buying there's you know
a good chance that it is a high quality car
that is being advertised or it's what we call
a lemon a dad a bomb etc someone saying
Harry this is a high quality car but really
it sucks it's to break down in a month and
you've wasted your money the seller has perfect
information they know the car they're selling
is either high quality or if it's a bomb and
they're just trying to rip you off and both
are going to try and say it's high quality
so you have that problem of incomplete
information so as a buyer you know there is some
risk you can't discern the difference so what
you're going to do as a buyer is take
those probabilities into account there's a 50
percent chance it's going to be a high quality
car it's a 50% chance that's a bomb so you're
gonna pay the full price of a high quality
car no you're gonna take this risk into
account and probably probably offer an average
of these two prices so the high quality
secondhand cars 15 grand and the bomb literally
you know is worth nothing then you offer like
seven thousand five hundred dollars that's
what you do if you were completely risk neutral
but what this means is if you're a seller
with a high quality car why would you ever
sell it for you you'd only be willing to
accept let's say 15,000 or above or 14,000 or
above buyers aren't offering this there's
no way to convince them in this type of market
that your car is actually high quality and as
a result what will these sellers do they're
gonna they're gonna get a really loud beep
on their on their email that's what's gonna
happen um they're gonna they're gonna leave
the market they can't sell their car for
what they're willing to accept so they just
leave the market now what happens is all the cars
actually were 15,000 out of the market so
the highest quality cars now are 14,000 so
everyone knows it's now the highest quality cars
have left the market like the second
highest quality and all the the lemons at zero
and the average between these second highest
quality of cars, let's say we're at $14,000,
a lemon zero is $7 ,000. So now buyers are
going to offer $7,000. And it's the same issue
for those with the second highest quality
of cars. They're not going to sell at
that price, so they leave the market as
well. And what's going to happen is this process
continues until the only cars left in the
market are lemons. So this is how this
adverse selection problem results in the
unraveling of the market when there's
incomplete information. And that means there
are buyers who would be willing to pay $15
,000 for a high-quality car. They just can't
tell if it is or not. As a result, we have
this very inefficient outcome when there's
really no trades occurring in the
second-hand car market. Obviously, there are
trades in the second -hand car market, and
this is because there can be policies put
in place by government to mitigate the
incomplete information problem. So the big one
here is certification. So I've been looking
at second-hand cars for a while, and if
you go on to any of the dealer's websites, they
have some used cars, but then they have
certified used cars as well, which comes
with documentation of crashes it's been in,
how many miles, etc. They cost a bit
more, like there's a premium of like
$2,000 on it, but that's because you're
having this knowledge that you're not
getting a limit. Insider trading is a
very common example of incomplete information.
If you knew that some people were allowed
to you know um it wasn't illegal to do
insider trading a lot of people wouldn't you
know um invest in the stock market because
if you don't know and other people too you're
just a sucker essentially which means we can't
get good information about which companies
are productive which ones aren't etc
so clear rules against insider trading and
there's regulation over the truth that companies
can can the things that they can say in
advertising in lending and also we enforce
contracts so the seller could you know promise
you that you know this is a good car
when it's not we can enforce those sort of
things in society that's how we solve the
incomplete information all right so we're done
with market failures before we get to the
quiz actually i was literally just on twitter
and i saw this and i thought it was a really
funny example not funny it's kind of sad
but um an example of a negative externality
so this paper literally just came out and they
find that a cancer diagnosis increases
the likelihood of criminal behaviour,
representing a previously overlooked negative
externality on society. So the negative
externality is that third parties have
nothing to do with the cancer diagnosis,
but if it increases crime it affects
third party people, I should say third
parties in general. Does this remind
anyone of any famous TV shows from like the
late 2000s, Michael? Yeah, this is
literally Breaking Bad. So Walter White's
whole criminal empire was built
on him getting his cancer diagnosis, So
I thought this was quite relevant
and interesting in terms of negative
accident allergies. Okay, great, so let's
go to the cahoot. So this one's seven
questions, so I added in an
extra question. Remember, put your ten numbers for your PUID. You can't upload the
scores otherwise. And does anyone have
any questions about market failures before
we kick this off? So, I should
expect 100% correct answers on each
question then. Is anyone still trying to... Just let me know
when you're done. Good thing about having
the quiz now, rather than the end of class,
is I'm in no rush. Is that you? Okay,
let's get cracking. Which of the following is not a market failure? Incomplete information,
market power, price controls or
externalities better to guess and not guess
you can use the pin just to login for for
the person just coming in okay so the answer
is price controls so market power we
didn't fully discuss it but this is a market
failure so when there's a monopoly or something
like that there is market inefficiency
and I mentioned this on the first slide
the reason why it's price control so yes
when you put in price controls it creates
distortions in the market but this isn't the
free market this is a government implementing
a policy of price controls which moves
it away from the efficient outcome hence
why price controls is not considered a
market failure we're interested when the market
alone the free market mechanism results in
efficiency yeah next one an externality
is a cost of benefit of a market activity
that affects a third party true or false a
little bit of a softball hopefully to get
everyone back on track okay great almost
unanimous that's just the definition okay
same later if you're still there in two more
questions I'm going to elicit your confidence
level of winning next question a
negative externality results in production
of a good and socially optimal more production
of a good than socially optimal less
the same amount or cannot determine
negative externality okay so this is this is
more so why is this is the case is because
neither the sellers or the buyers take into
account these extra costs they have their own
private valuations and they'll trade as such
so no one's taking into account these
extra costs and because of that there's more
production of the good, a higher quantity of
the good at equilibrium. So remember when we
offset this externality by putting in the
excise tax, it shifts the supply curve up
and to the left and at the new equilibrium
where that new supply curve intersects with
the demand curve, we're going to have a higher
price and as a result less of the good. So
that means a negative externality results
in more production of a good than socially
optimal. So when it's socially optimal
there's going to be less production so hopefully
it was the wording a little bit that
confused you rather than the mechanism but just
keep in mind how negative externalities and
positive externalities result in inefficiencies
in the market now we have a new leader
pancake deer i think if a good is not
excludable and rival it is a private good
common good public good I need to learn how
to spell clearly because privé
is not private. Not excludable and rival. Okay, great.
Majority got that right. It's a
common good. Remember, with a
common good, anyone can use it. It's common.
It's for everyone. But one person's use
will impact another person's quality of
use. So the examples we used were like overfishing.
We had the cows in the paddock example.
And also, I think a good one is my
office hours for this class. I can't exclude
anyone, everyone can attend, but I have
limited hours. So if you take up an hour of
my time, no one else can come and see me
for that office hour. So it's rival in
the sense that your usage of it affects
other people's usage. Okay, same later. So this next one
I believe is 30 seconds. It's a bit
more visual. So it's 30 seconds, you've
got an extra 10. In the following
image, what area is the dead weight
loss in this image? 30 seconds is it
area b c h or i most people got that
right that's awesome so yeah it's in between
the two supply curves lies above the demand
curve and it's in between the width of
the overproduction which is the quantity of
equilibrium in the inefficient market so market
equilibria and then the new equilibrium at
the socially optimal so in between those
areas great job everyone They're still
the same leader. Who is Pancake Deer? Right. What's
your name again? Andrea. Andrea. You haven't won one
yet, have you? Okay. How confident
are you going to stick this
out to the end? 10%. 10%. So 90%
chance you don't win. Pretty high.
You've got to back yourself a bit more. Okay. Penultimate
question. For America, the army
is what type of good? Private, common, club, or public? Most people got that
right. Yes, it's a public good for America,
because if you're in America, if you're
a citizen, or if you have a visa, the army
is meant to protect you, and my use of
it doesn't affect your use of it, and no
one can be excluded. And the qualifier
of America is really important here,
because for my friends and family back home
in Australia, they don't have this same
protection from the American army.
They're excluded from it. So that's why the
demarcation of the population is so
important when trying to figure out what
type of good it is. we have a new leader
with one question um left who is um king
what is that is that a sponge or a brain
who's our brainy king what's your name cole
are you also 10 for hanging on um i don't
know i got 500 points okay so so give me
your confidence level what as long as i get
it right okay okay nice i like that
confidence last question For a linear public
good, every person has an incentive
to give nothing to the public good.
True or false? Yes? Did you
get it right? Oh, no. Oh, wow. This is the issue of
calling people out in public, trying to
boost up confidence, and we'll see if
you hang on or not. Ah! Congratulations, that
was a topsy-turvy final couple of
rounds. You can come up and choose between
both the kangaroo and the koala, or one of
the chocolate bars. next time call next
time popular choice I have so many chocolate
bars could no one ever chooses I should
probably offer both in to try and
incentivize but to choose them all right great
so the most important thing is you all got
some extra credit from that or or points
towards the threshold of extra credit that's
what this is all about at the end of
the day the call and the kangaroo is nice
there. And we're going to get on to our
final topic that will be assessed on the
midterm. So a couple of things to note in
terms of housekeeping. If you saw my announcement
last night, the exam is going to
cover topics one, two, like basics or whatever
it's called, and this one, which is
actually, you know, the third chapter. So the
intro stuff, the market dynamics, market
failures, and elasticity. And this is good for
you for a couple of reasons. The first one
is speaking to Ishita, my TA, she's TA'd
managerial before and obviously took it
herself. She said the the section that causes
the most trouble in the first midterm is
elasticity and historically this is the third
topic that's success not the fourth because
mostly when this is taught the fourth topic
consumer choice is done after this and
on the exam. So by having this as the last
one before the midterm it means it's going
to be the most fresh in your memory so that's
great and the second thing is for the next
homework which i'll probably release on
monday after we do this lecture it's going
to have elasticity on it so you're going to
have a lot of practice right up until the
exam and by right up to it i mean the
homework is due on the sunday before the exam
you don't have to submit it the day before you
can do it whenever you want that week i
just wanted to give you all an opportunity
to work whenever you So far we've looked at
qualitative changes, so directional changes, increasing or decreasing. For example, if income increases,
does demand for a good increase
or decrease? We know based on
the definition of if it's a normal good or
an inferior good, this will help us determine
the direction, or if the price of a
substitute or a complement increases, demand will
increase or decrease respectively and for
a producer, if the input prices increase,
producing each unit becomes more expensive,
which means the supply of goods will decrease
this is really good information we don't
want to know directional changes all the time
but we sometimes want to know more than the
directional change if you're a manager or if
you're thinking about ways to incentivise
people in the population you want to know by
how much people's behavior changes which
is quantitative changes so for example if
someone's income increases by one percent how
much more demand will there be for a normal
good will it increase the demand by only 0.5
percent what about one percent what about 50
we don't know just from the directional changes
but using elasticity and the formulas
associated with it we can figure these things
out so this this this topic is a bit formula
heavy but I'm going to take you through it
all and it's actually quite intuitive and
everything is linked to each other at the end
of the day so elasticity is just a measure of
the responsiveness of one variable to changes
in another variable the percentage change
in one variable that arises due to a given
percentage change in another variable so
if we've got these two variables g and s and
we want to know how much g changes in percentage
when s changes we have this formula of
elasticity of g s so this triangle here this
is just the rate of change or delta so we
have the percentage of change in our g variable
divided by the percentage change in our s
variable and that will tell us that when s
changes by some percent how much will g change
using this formula and sometimes we have a
functional relationship between two variables
so our demand curve is a functional relationship
quantity depends on price in this case
if g depends on s so if s increases something's
going to happen to g we can formulate
it like this and I'll break down how we get
to this in the end. So this D here is just
the calculus version of difference. It's the
exact same thing as our delta, our triangle.
It's just the change. So the change in G
divided by the change in S multiplied by at what
point we started at S divided by at what
point we started at G. So as we saw before,
when we have this function, G is F,
this function of S, we have this elasticity
formula here on the previous page and here
we have our linear demand function so
quantity demanded depends on these four
things the price of that good x the price
of some other good, a substitute or a
complement y income and h, everything else
and using this formula we can calculate
the change, the magnitude of change in
quantity when the own price the price of
that good, px changes the cross price
elasticity how much quantity will change
when the price of this other good Y
increases or decreases and income elasticity
how much more of this good will you
demand when income increases or decreases
by a certain amount and the formula is the
same for all of them what we care about
is assessing this dependent variable
which is quantity so the change in quantity
over the change in what we're interested
in which is PX here multiplied by the
point we started at for what
the independent variable is, here
price, divided by the independent
variable quantity. So now I'm going to show you how we get
this formula. So recall one way of
calculating percentage change is just the
percentage change is equal to the change
divided by the original. So for example, if I
want to see how much better or worse in
percentage, you do on exam 2 compared to exam
1, I just take your score from exam 1,
see how much higher or lower you get in
terms of your score, and then divide that
numerator by what you got in exam 1. And
that's the percentage change of how much
better or worse you did. Another example
is, let's say, quantity increases
from 10 to 12. The percentage change
is the difference, the change, so 12 minus
10. Two units is increased by two. The
original is 10, that's what we started at. So this
is a 20% increase. Fairly
straightforward stuff. And we can do
this for both quantity and for price. So percentage change
in quantity demanded is just the change in
quantity divided by the original amount
of quantity. So the original amount of
quantity is Q, and our change in quantity is
just our delta Q, the rate of change of Q.
How much did Q change? Same thing for
price as well. The change in price,
the percentage change, is
just the change in P, our delta
P divided by P. So, we can calculate our price elasticity
of demand, our formula here, the
percentage change in Q divided by the
percentage change in P, also sometimes denoted
in this fashion. So, we know that
this, the percentage change in Q, is
just delta Q divided by Q, that's our
numerator, and our denominator is the
rate of change, the percentage range
of change in P, which is just delta p divided
by p and for those of you who are less
confident with your math when we have
like this like kind of double denominator so
the q is going to go down to the bottom
here so you're going to have q multiplied by
delta p and then we have another denominator
here and when you have that second
denominator you just move the number under
it up to the top. So we get delta Q multiplied
by P divided by delta P multiplied by
Q and this just gives us delta Q divided
by delta P multiplied by P divided by Q and
if we go back here, remember our D, our
difference is the same as our delta
triangle this is the exact formula that's
how we get there also important to note
as we'll show, this comes up you know a
bit later on as well this part here the
delta q divided by delta p is just the
inverse slope of our inverse demand function
so our inverse demand function is priced
in terms of quantity remember and that
means this changing q divided by changing p
is just one divided by the slope why so as
you can see here the slope of any functional
line or if it's a straight line it's
rise over run, if it's more of a quadratic curve,
it's just our tangential point,
is the slope. So in this case
here, if we go from this point
to this point, our rise, or our
fall in this case, is 30 to 25, minus 5,
and our run is 20 to 30, which is 10, so
minus 5 divided by 10 is minus 1 half.
That's our slope. So the slope of the
demand curve is rise over run, and our
rise is our change in P, and our run
is our change in Q. So the inverse
slope of the demand curve is 1 divided
by the slope, which equals 1 over
rise over run. As we said, rise over run
here is just this, so we plug that in here.
And as before, when you've got this double
denominator, you take whatever's at
the bottom and chuck it up top. So 1 times
the change in Q is just change in Q
divided by change in P. And that is the
same thing we see in one part of the
equation of elasticity right here. So it's
just 1 over the slope of the inverse
demand function. So to make it even
easier, the slope of the demand curve
Q is just the inverse of the slope of
P. So as you can see here, when we
look at Q and P here, you have minus B, and
when we put it in terms of B, we have minus 1
over B. So if we take the inverse of this,
so we have 1 divided by 1 over B, or negative
1 over b it just turns out to be negative
b as well so if you get given it in terms
of q you can just take whatever's out the
front of p minus b and that's going to be your
change in q given the change in p but if
you have this function you can just take the
inverse of it and you get the same answer this
is how it's all related so we've got two examples
here to hopefully drive this point
home so this is going to be an example heavy
topic there's a lot of formula solving, and
I can just, you know, tell you how Stambert
experiences the best thing here, especially
with an exam coming up. So let's say
the inverse demand function is the price
equals 100 minus 2q, and we can rearrange that.
We know q equals 50 minus 0.5p, just doing
the algebra here. If the price is $10,
what is the elasticity of demand, own
price demand we know this elasticity formula
the elasticity of the quantity of x
given the price of x is just this formula we
had there and we have two integral pieces
of information we know what the change
in q over the change in p is we have it
here remember it's just this or the inverse
of this it's going to be minus 0.5 that's
how much q will change if p changes by one
1%. Sorry, not 1%. That's how much Q
changes if P changes. And the next part
we need to know is Px divided by
Qx. And we have Px here. We've been
told Px is $10. So as a result, we
get minus 0.5 times 10. I skipped a
sec. Because we know the price, we can
just plug the price back into either of
these functions, and it gives us the Q.
So if price is $10, then we can see
that Q equals 50, Minus 0.5 times
10, which is 45. So we have all the
pieces of information that we need. We
know the change in Q divided by the change
in P is minus 0.5. We know the price is 10 and the quantity is 45. And that gives us an elasticity of minus 0.11. And I'll break
down in a second what this actually means. In this second example,
we have the same functional form. but now
it asks us what is the price of the demand
curve when the demand curve is unit elastic
so that means it equals one or minus one when
it's unit elastic i'll give these explanations
in a second but once again we have enough
information to solve this we're told what
the elasticity is here so the left hand side
is minus one that's what we're told here
the change in q over the change in p is still the
same we have the same functional form of q
equals 50 minus 0.5p, so it's minus 0.5,
and now we have these two unknowns, Px and
Qx. So Px divided by Qx. And the thing
you need to know is Px and Qx have
this relation. So what we want to
do to the right-hand side is get it in
terms of one unknown variable. We can't
solve this with two unknowns because it's
only one equation. But, we know that
Qx, or Q, equals 50 minus 0.5p, so we
can substitute Q for 50 minus 0.5p,
which we do here. And now we have
everything to solve the equation. So if we multiply
both sides by minus 2, this becomes 2,
and we get rid of the minus 0.5. We take this
50 minus 0.5p to the other side, and we get
100 minus p equals p. Take this p to the
other side, 2p equals 100, and we get the
price equals 50. So at what price is the
demand curve elastic? it's a price equals
50, and just to be fully complete
here, we can also find the quantity when
it's elastic as well. So, what do these
things inelastic, elastic, unit,
elastic actually mean? So, there are
two important aspects of elasticity. Is the sign of
the relationship positive or negative? So, if it's negative,
it means as the price increases, the
demand will directionally decrease. As we
know with our law of demand is that if
the price increases the quantity
will decrease. So that's why it's
negative before. But we know for
certain things like with substitutes
or normal goods as the price of the
substitute increases or as income increases
quantity will increase. So it
will be positive. The next thing we
want to know is the absolute value
of elasticity to the magnitude
relative to unity. So for those who
don't know, what the absolute value is,
you put any number in there, and it
transforms it into a positive number.
So if you have minus three, it transforms
it to three. Minus a half transforms
it to a half. So, if the number
is higher than one, it's elastic, and
what that means is people are highly
susceptible, or highly responsive
to changes in price. So a slight change
in price will change quantity
demanded by a lot. On the other hand,
if it's less than 1, what that means is people
are unresponsive to price changes. It's
inelastic. So prices could change a lot,
but the good will be demanded pretty much
the same amount. And I'll tell you why this
is the case shortly. And finally, if
it equals 1, it just means it's
unit elastic, which means a 1% change
in the price of X will result in a 1%
change in the quantity demanded for X, So,
negative 1% in this case. So, what elasticity
of demand measures, as
I said before, is the responsiveness
of consumers' desires for a product
when prices change. If it's elastic,
people are very responsive. Any slight
change in price will change their
purchasing decisions. And if it's inelastic,
people won't change their purchasing
decisions, even when prices rise
or fall by a line. so as you can see
here we have these two examples of how we
kind of graph perfectly elastic and perfectly
inelastic demand and the more elastic
something is the more flat the demand
slope is and the more inelastic it is the
steeper the slope is so if you look over here
on this side you can see that the quantity
demanded is always here no matter what the
price is it could be free and this is the
demand, it could be a billion dollars,
and the demand is the exact same. So there's
no change, no response to price. Whereas
perfectly elastic, a slight change in
price will completely change whether people
will want it or not. And I have some
examples on the next page that will
hopefully illuminate what's going on. So
let's start here. So this is perfectly
elastic. And what this means is a sense
change in either direction is going
to cause either everyone to want it
or no one to want it. So an example is a
$10 note. How much do people value a $10 note?
Would you pay $10 and one cent for a $10
note? No, like you lose a cent. So no one's
going to demand it there. But as soon as you
slightly change the price to $9.99, you're making
one cent. Everyone should demand the $10
note for $9.99. So this slight change in
price results in no one wanting the good to
everyone in the world. Perfectly elastic. Something that
is relatively elastic is strawberries. So as you can see,
a small change in price, so
let's say price decreases by a little
bit, then you can see a large change
in quantity. So people are
very responsive. For example, I like
making smoothies in the morning, and I like
making Greek yogurt bowls at night, and
strawberries are an ingredient I regularly use. But
sometimes, looking at the supermarket
prices, the grocery store prices, strawberries
could increase by a dollar and I'm like
okay I'll just get raspberries or blueberries
or something else instead so I substitute
away from it I'm very sensitive to the price
and it's the same like this with a lot
of goods in the in the grocery stores something
that's relatively inelastic so you can
see a pretty big change in price only results
in a small change of quantity demanded
is something like electricity so if the
prices of electricity go up a lot of people like
okay I'm still gonna just have the heat on
i don't want to like be cold in this in this
hell hole that is is west lafayette during
winter so as a result people use very similar
amounts you might cut back a little bit
but people don't just decide to use no
electricity when the prices change a little bit
finally something that's perfectly inelastic
is um uh you know life-saving surgery for
your pet people would be willing to pay
one dollar for that obviously but a lot of
people pay even like five thousand dollars
for it something for a lot of people that's a
month so their demand for it doesn't change
even if the price has changed a lot so what
causes something to be more elastic or
more inelastic so the three things that we're
going to talk about the main three things
that determine price elasticity of demand
are substitutes share of the budget and time
so substitutes is pretty straightforward
if there are more substitutes then you're
going to be more price sensitive because there
are other things that you can buy if the price
of the good increases. You'll move your
demand away from it. So like the examples
here is something like gas is pretty,
doesn't have any substitutes if any at
all. So the price rise or fall won't
really result in you getting more or less
of it if you need it. However then something
like this, like you've got all these
types of sodas and other drinks and stuff,
if the price of Coke Zero went up by like
a dollar, I mean, I'd probably still
buy it if I'm being honest. I've got an
inelastic demand for Coke Zero, but people
would substitute towards Pepsi or Diet
Coke or other things like that. So the
more substitutes there are, the more options
you have to move away from it. So when
prices change, it's going to affect your
quantity demanded. Okay, this one
is share of the budget. And what
this means is, let's say
everyone's probably biggest expense is rent. So if your rent
increased by like $500, dollars you're going
to have to like try and find another place to
live or like a smaller apartment or a share
house or get extra people in the house
etc just because you have to if something
is like 60 of your budget and that increases
by a lot there's no wiggle room anywhere
else to change to fit into your budget so
a lot of the time for your larger expenses
they're more elastic simply because you're
forced to respond whereas for something
smaller like like toilet paper if your
favorite toilet paper increases by a dollar
and you're adamant on buying this toilet
paper such a small share of your budget that
you don't actually need a change you might
change for substitute reasons but it's only
going to be like 1 % of your budget so you
don't need to change it for that reason
you can maybe buy one less coffee a week or
something like that finally time the
more time you have to respond to price
changes the easier it is to find another
option however if you need a change in the
moment like a lot of options aren't
available, less option value, as a result
it's going to be more inelastic when you
don't have this time. Yeah? You're three
slides ahead, yeah I'll come to this, yeah. So when speaking about
substitutes, as you can see here, this is
the old price elasticity of certain goods,
so as you can see here, whole milk is
minus 1.1, the absolute value of this is above
one so this is elastic and the idea behind
this is it substitutes the whole milk you
can get 2% you can get skinny you can get you
know almond you can get oat etc etc so there's
a lot of substitutes but when we categorize
it as milk as a whole so when we look
at just milk there's not really any
substitutes to milk like for things like cereal
and smoothies and stuff as a result it's very
inelastic same thing here like meat in general
is very inelastic, but a specific type
of meat, like steak, which has many
substitutes, is elastic. And for some reason,
T here in the US is elastic. If you
got this data from the UK, I'm telling
you that T would be like minus 0.2
or something like that. They can't
live without their T. So this is how
substitutes can affect whether something's
elastic or not. So I'm going to skip
over the share of the budget. I think that
one's pretty self -explanatory. And here's
an example of time. So imagine you're driving
your car, and you run out of gas in the middle
the road and you see that gas prices have
just increased by $75. You're probably not
going to be like, oh yeah, there's
other things I can do. You don't have any
options. You need to get gas in your car
to get home. As a result, in the
immediate run, there's no time to adjust.
You're like a prison to the price system
in that situation. In the short run, there
is time to partially adjust. In the next
couple of weeks, you don't have to go to
the same gas station. You can try and find
others. You can try and find other ways
to get different types of premium or non
-premium in your car. And in the long
run, you have complete freedom
to adjust. So this price has
increased, and it's going to be like that
for the long run. You ditch your car,
you get a bicycle or a motorcycle or
something that doesn't need the petrol or
gas. So more option value in the long
run, more elasticity. So instead of
insulin, we're going to talk
about Daraprim. So Daraprim is a
necessary drug for people living with HIV and
people with organ transplants without it
they will die it's a life saving drug and
there's only one supplier of this drug or
historically there was only one supply and
the pill costs $13.50 like not terrible for
a life saving pill so is Darapin
elastic or inelastic? sorry? inelastic yeah like
if you don't take it you die so you'll pay
for it if it's $1.13 .50 or in the infinite
amount of money like you'll still demand
it even if you can't afford it there's
a famous case going back 10 years of
this man here martin shkreli and what shkreli's
company did churn pharmaceuticals they
bought daraprim and remember there's only
one supply they're a monopoly and they
raised its price overnight from $13.50 a pill
to $700 this is an increase in price of
over 5,000 percent and it led to certain
headlines like this martin shkreli the most
hated man in america etc etc so this was
a whole thing and this is the idea if
there's an inelastic demand for something
and only one supplier of them no competition
pushing prices downward they can do
exactly this this profit maximizing for them to
like have outrageous prices even though
a lot of people in this room rightfully
probably got the ick from this so this
is why market power monopolies can be a
market failure as well and i'll get to the more
technical aspects of that in a couple of
weeks but So I think it's a really good
example of if there's an elastic demand,
we're kind of at the mercy of the producers
and the market structure. So exact same thing
with the insula. We're going to finish
off in this pretty funny video that talks
about the elasticity of something that's,
I think, quite interesting, organic food
and farmer's markets. I care about
the environment. About hunger. About food. One-third of all food
produced worldwide is wasted. And
we needlessly pollute by shipping
perishables all over the world. That's
why I believe in buying seasonal,
local, whole foods. Unless it's inconvenient. I always buy produce
from my local farmer's market.
Unless it's raining. Or if it's
too hot outside. Or too cold. Or if
I wake up too late. Or if I have something
else going on that day. But otherwise,
yeah, totally. The farmer's market. Because the food we
buy affects all of us. All of us. When
I support local farmers, I support my
own community. I support a cleaner environment
for everyone. So when I do get to
the farmer's market, I'm making a
difference. Except they don't buy
onions there, because they're like $5 for
a single onion. I could buy a whole
bag of onions at the grocery store for
that. Ooh, and meat. Right, I don't
get meat there. Or milk. I mean,
it looks great. It looks delicious. But I'm not made of
money, and I'm not sure I'd be able to
taste the difference. but I definitely buy
carrots and shit. Carrots and
shit? Sometimes. Unless the produce
looks kind of shitty. Sometimes
it looks, like, shitty. Or it's a
vegetable I've never seen before and
I'm scared of it. What is this thing
and how do I cook it? But I'll still
buy margarita mix from that one stand.
Or artisanal soap. Or tacos from the
taco truck that sits idly next to
the market all day. It still counts, right?
Sure, it's still at the farmer's market.
We're thinking more about our food. Because
we're living in a world over one trillion
dollars of food gets wasted every year. 25%
of all calories produced never get consumed.
I think about these things. So with the
exceptions I just mentioned, I shop at the
farmer's market. The farmer's market. Unless
I'm really hungry. Then I just go to McDonald's
or something. But only when I'm hungry.
Or tired. Or if I'm just in the mood for
some McDonald's. But I definitely buy a potato
or something from the farmer's market once
a month at least at least certainly once
every two months because i care about the
environment although i do also drive to the
farmer's market that's probably not good well
at least you could say i'm trying kind of
trying to kind of yeah so i i think this is
a cute video but it illustrates yeah okay
katie maravich um in a couple ways the one
part of college humor thank you for watching
click here to subscribe to the channel click
here I think there's two things that really
like I think illustrate the idea of elasticity
the first is that little bit about the
onion costing $5 but there's a substitute
like non-organic onion so you can get the
supermarket much cheaper so people have high
elasticity when it comes to something like
these farmer market prices and the others
like convenience and stuff as well like
they're pretty hard to get to when it's like
snowing and cold people don't want to go so it's
elastic in that sense if it's something
that's inconvenient you'll get something else
even if it is cheaper and finally has anyone
here been to the the market down in in
West Lafayette on the on the Saturday yeah
so a couple people I highly recommend it a
bit about the taco trucks got me good because
you have these like you know non-organic
trucks of food and coffee and stuff and they're
always the most popular it seems I
thought that was pretty humorous all right
that's it for today we'll continue on with elasticity
on Friday um yeah no more announcements
or anything so enjoy So the videos and
the photos and stuff, there's this weird thing
where I'm not meant to put up photos and
stuff like that. I just didn't know. So you'll
see, all my stuff will have the graphs,
the writing, I'll leave out the maths to
fill in, but all the engaging fun stuff,
you'll see the redacted bytes. instead of I'll
show you actually I mean I I noticed because
I know I know that would have noticed yeah
instead of you know instead of this I was
just had read a bullet okay yeah so like it's
just the whole thing that I'm trying to abide
by not well clearly but yeah I just yeah
no no worries yeah yeah have a good one