Microconomic Essentials

Lecturer: Dr Meshel Muzuva

20 April 2024
WEBINAR OUTLINE :UNIT 5

 GOVERNMENT INTERVENTION
GOVERNMENT INTERVENTION
Government Intervention
Maximum prices
 A price ceiling occurs when
the government puts a legal
upper limit on the price that
can be charged for a good or
service.
 If the government sets a
maximum price of Pm below
the equilibrium price of P0

 This results in an excess

demand of Q2 – Q1 (or ab).
Activity 1
The following demand and supply curves for an economics course
illustrate the impact of a price ceiling of R2 500 on the course fee.
Which of the following statements are correct with regard to the
above?
a. Owing to the excess demand that is created, a rationing
mechanism needs to be put in place to determine which students
will be allowed to take the course.
b. In the absence of the price ceiling, only those students who are
willing and able to pay R3 500 will be allowed to take the course.
c. Owing to the price ceiling, more students will be enrolled for
the course.
Activity 2
“On 1 March, South Africa’s new minimum hourly wage rate came into force, rising 9.6% from R23.19 to R25.42
per hour. This rise is above consumer price inflation (CPI) of 6.9%. But with food inflation rates of 13.4% in
January 2023, which affects poor people disproportionately, labour activists at the Casual Workers’ Advice Office
(CWAO) have called the increase a “political attack on the working class.””

Assume that initially the market for labour is at equilibrium at point A on demand curve D2 in the Figure. If the
new minimum wage rate is enforced above point A…
A. the demand curve will shift to D3
B. there will be an excess of labour.
C. there will be a shortage of labour.
D. the demand curve will shift to D1
The welfare cost of maximum price fixing
Consumer Surplus is the difference
between what consumers pay and
the value they receive, indicated by
the maximum amount they are
willing to pay
Producer surplus is the difference
between the amount the producer
receives and the minimum amount
the producer is willing to accept.
Videos:
https://www.youtube.com/watch?
v=jNdXt5GqoMI
https://www.youtube.com/watch?
v=r1Xq9FcxDB8
The welfare cost of maximum price fixing
Consumer Surplus is the difference
between what consumers pay and
the value they receive, indicated by
the maximum amount they are
willing to pay
Producer surplus is the difference
between the amount the producer
receives and the minimum amount
the producer is willing to accept.
Videos:
https://www.youtube.com/watch?
v=jNdXt5GqoMI
https://www.youtube.com/watch?
v=r1Xq9FcxDB8
nimum prices (price floors)

A price floor means that

the government puts a
legal lower limit or
minimum price that can
be charged for a good or
service
The welfare costs of minimum price fixing
Activity 3

Which of the following is correct with regard to maximum prices?

[I]: It will only have an impact on market price and quantity exchange if it
is set below the equilibrium price.
[II]: It would never stimulate black market activities.
[III]: If it is set below the equilibrium price, it results in excess demand.
a) [I] and [II] only
b) [I] and [III] only
c) [II] and [III] only
d) [I], [II] and [III]
UNIT 6 ELASTICITY
LECTURE OUTLINE

 Define elasticity
 Explain the meaning and significance of price
elasticity of demand
 Distinguish between five categories of price
elasticity of demand
 Define income elasticity and cross elasticity of
demand
Introduction

We have analysed the direction

of change when demand or
supply changes. Now let’s
analyse the size of those
changes.

By how much will price and quantity change if

demand or supply changes?
How will a change in the price of a good or service
affect the total amount that consumers plan to
spend on that particular good or service?
UNIT 6: ELASTICITY
Elasticity is the measure of the responsiveness of a dependent variable to changes in
an independent variable
The price elasticity of demand

The price elasticity of demand is a measure of the sensitivity of quantity demanded to

changes in price.

Price Elasticity of Demand (Ep) = % change in quantity demanded

% change in price
PRICE ELASTICITY
As a general rule, we can state the following:
 If the percentage change in price is greater than the percentage change in quantity demanded, then
the price elasticity coefficient is less than 1. This applies to things such as salt, medical services, fuel,
beer and so forth. In these cases consumers are less responsive or sensitive to a change in the price.

 If the percentage change in price is smaller than the percentage change in quantity demanded, then
the price elasticity coefficient is greater than 1. This applies to things such as private education,
restaurant meals and fresh tomatoes. In these cases consumers are more responsive or sensitive to a
change in price.
RELATIONSHIP BETWEEN PRICE ELASTICITY OF DEMAND AND TOTAL REVENUE

 When ep is greater than one, total

revenue increases as the quantity of
cappuccinos increases.

 When ep is equal to one, total

revenue is at a maximum.

 When ep is less than one, total

revenue falls as the quantity of
cappuccinos increases.
Categories of the Price Elasticity of Demand

There are five categories of Price elasticity of demand:

Categories of the Price Elasticity of Demand

Perfectly inelastic demand (ep = 0), consumers will plan to purchase a fixed amount of the product
regardless of the price which is charged. In this case, producers can raise their revenue by increasing
the price charged for the product. As the quantity demanded does not change, raising price results in an
increase in total revenue. Remember TR = PQ.
Categories of the Price Elasticity of Demand

Inelastic demand (0 < ep < 1), the percentage change in quantity demanded is smaller than the percentage change
in price. Producers have an incentive to raise their prices in order to increase their revenue. Likewise, there is no
reason why producers would decrease the price of their product as the revenue received from the increase in
quantity demanded will not offset the revenue lost due to the decrease in price.
Categories of the Price Elasticity of Demand

Unitary elasticity (ep = 1), The percentage change in quantity demand is equal to percentage change in the price of
the product. Thus, producers would not gain anything by increasing or decreasing the price of the product.
Categories of the Price Elasticity of Demand
Elastic demand (1 < ep < ∞), The percentage change of quantity demanded is greater than the percentage change in price. When
producers are faced with elastic demand, decreasing the price of the product will raise the total revenue received by producers
(this is as a result of the property of elastic demand, also remember TR = PQ). There is no incentive to raise the price charges for
the product as this would decrease total revue (the opposite of decreasing the price will occur).
Categories of the Price Elasticity of Demand

Perfectly elastic demand (ep = ∞) Consumers are willing to purchase any quantity of goods at a certain price, raising
the price of the good will result in the quantity demanded falling to zero (even if the price is only raised slightly).
Price elasticity of demand: a summary
Activity 1

1. If the % change in P is greater than the % change in Qd, then demand is …

a) inelastic.
b) elastic.
c) unitary elastic

2. If an 8% change in price leads to a 12% change in Qd, the demand is

a) inelastic
b) elastic
c) unitary elastic
Activity 2

You are given the following diagrams (a and B) and must indicate whether the demand is
relatively elastic, relatively inelastic or unitary elastic.

Figure a figure b
Income elasticity of demand
A measure of the responsiveness of the quantity demanded of a good to
changes in consumer income, ceteris paribus

% change in quantity demanded

% change in income
Income elasticity of demand

Q↑ Q↓

Income ↑ Income ↓

Q↓ Q↑
Normal good
(0 < ey)
Income ↑ Income ↓

Inferior good Essential good Luxury good

(ey < 0) (0 < ey < 1) (1 < ey < ∞)

-∞ 0 1 ∞
The cross elasticity of demand
The responsiveness of the quantity demanded of a particular good to changes in the
price of a related good

% change in demand for product A

% change in price of product B

Positive sign: substitutes

When the price of one increases, the quantity demanded of the other
increases.

Negative sign: complements

When the price of one increases, the quantity demanded of the other
decreases.
The cross elasticity of demand

Q↓ Q↑ Q↑ Q↓

Price of Price of Price of Price of

related related related related
good ↑ good ↓ good ↑ good ↓

Complements Substitutes
(ec < 0) (0 < ec)

-∞ 0 ∞
Activity 3
Salaries are declining in South Africa, but more people are getting paid, new data shows. The average salary in
South Africa has shown the most significant month-to-month fall in March, declining 5.6%. This has led to South
Africans having less disposable income and increasingly relying on debt to make ends meet, the group said.
Use the figures below to answer question 8 that follows

Which of the figures correctly indicates the effect of a decrease in James’s salary on the demand of chicken liver which
is considered to be an inferior good?

a) A

b) B

c) C

d) D
Activity 4

1. Suppose the cross-elasticity of demand between two products, A and B, is negative. If the
price of product A increases as a result of a decrease in the number of firms supplying the
product, the quantity demanded will _____.
a. increase for both products A and B
b. fall for both products A and B
c. increase for product A and fall for product B
d. fall for product A and increase for product B

2. Suppose the cross-elasticity of demand between two products, A and B, is positive. If

there is a fall in the cost of producing good B, the quantity demanded will _____.
a. increase for both goods
b. decrease for both goods
c. increase for good A and decrease for good B
d. decrease for good A and increase for good B
What is it that you don’t understand?
THANK YOU