I.
Elasticity
Conceptually elasticity is always between 0 and –infinity. i.e, increase
in price leads to decrease in qty.
Elasticity = change in qty/change in price
Demand is considered inelastic if elasticity is between 0
& -1. i.e. increase in price leads
to increase in revenue.
Demand is considered elastic if elasticity is between -1 and
–infinity. Increase in price may lead to decrease in revenue. More elastic the
demand, more the decrease in qty with increase in price.
Higher the elasticity, less the mark up and go for higher
volume.
Elasticity of a group is the weighted sum of individual elasticity.
II.
Double
marginalization leads to
a)
Lower qty sold
b)
Higher retail price
c)
Lower profit (total for all parties, though
margin per merchant involved could be high)
Double marginalization means manufacturer selling to retailer and then to
customer. Each layer making its own profit.
When thinking about how to distribute resources (advertisement on google
or seats in a stadium) think about marginal revenue. Profit is maximum when MR
= MC. Sometimes, MC = 0 (eg. in stadium seats example)
III. Auction
First price auction: Highest bidder wins
and pays the highest bidding amount
Second price auction: highest bidder
wins and pays the amount bid by runner up. In SPA, always bid the value of
item.
Auctions
don’t pick up well when market is think i.e. when pricing is openly available.
IV. Market Efficiency
The first welfare theorem i.e. invisible hand states that
equilibrium in competitive markets maximize total surplus.
Taxes reduce the efficiency of the system. However, argument
is that taxes lead to distribution of wealth at the cost of reducing the total
surplus. Regardless of who pays the taxes (seller or buyer) the total volume of
transactions, government revenue, firm profits all remain the same. The loss in
efficiency is called dead weight loss (DWL). (lecture 13). More elastic the
demand, higher the DWL.
If demand is inelastic (gasoline), taxes are passed on to
consumers. The DWL created by subsidy is twice that created by tax (amount of
subsidy amount and tax are equal).
In markets with negative externalities (pollution,
overfishing), taxes can increase welfare. In markets with positive
externalities (innovation, vaccination) subsidies can increase welfare.
