EC 100 Class 1

1. EC 100 Class 1 Office: 32 L, 3.01 D Office Hours: by appointment Email: t.r.fetzer@lse.ac.uk

2. First Class Exercise • Maybe plot the grade distribution if you want, but don’t reveal individual students results. • Highlight which questions seem to be difficult. (you can also draw the distribution across all class groups if the sample is too small). • Review concepts of elasticity – in particular, what means elastic versus inelastic – students need to get familiar with the terminology

3. Question 1 • If price is below market-clearing level which of the following statements is true?

4. Question 1 • If price is below market-clearing level which of the following statements is true?

5. Question 2 • Which of the following is likely to shift the demand curve for coffee? Mark all that are correct.

6. Question 2 • Distinguishing movements along a curve versus shifts of the curve. [See Whitehead handout 2] • Demand curve shifts if there are changes in (1) consumer preferences, (2) changes in price of substitutes or (3) complements, …

7. Question 3 • When the price of a good rose by 10%, demand fell by 25%. What is the price elasticity of demand?

8. Question 3 • Define again the elasticity of demand – what does it measure – what is an example of elastic versus inelastic demand? • What is the effect of changes in supply on equilibrium prices, depending on the elasticity of demand?

9. Question 4 • The relatively new technology of fracking allows natural gas to be extracted from places that were not previously accessible. What would you expect to be the effect on prices in the natural gas market - mark all those statements you think are true.

10. Question 4

11. Question 5 • What would you expect to be the effect of the increase in fracking to produce natural gas on the demand curve for oil?

12. Question 6 • In 2012 the top 1% of income earners in the US earned 19.8% of total income, the highest share since 1928. There is a need for policies to address this problem. • Is the first of these sentences a positive or a normative statement? What about the second?

13. Question 6 • Positive: judgement free • Normative: carry subjective assessments.

14. Question 7 • The supply curve for a good has a price elasticity of 1. if prices rise by 10%, how much will supply rise?

15. Question 7 • Define elasticity of supply – how much quantity supplied increases, if there is a 1% change in the price. • Here price increases by 10% - we move along the supply curve • We do not make a statement about the “equilibrium” price (so we do comparative statics, holding all else constant – including demand). [i.e. we are “drawing” the supply curve]

16. Question 8 • The supply curve for a good has a price elasticity of 1. Suppose that demand rises by 10% for all prices. From this information, which of the following statements are correct? Drawing a graph may help you.

17. Question 8 • Prices and quantities will rise by equal amounts, The actual increase in the amount bought will be less than 10%. • Why?

18. Question 8

19. Question 9 • Suppose the government imposes a tax on all purchases of a good. Which of the following statements are true?

20. Question 8 Price, P • Imposing a tax on purchases (= shifting the demand curve down) • For a given price, consumers now get less quantity as the price they need to pay contains the tax per unit • Alternatively: think of upward shift of supply curve by the amount of tax Supply Curve Consumer Price Equilibrium price Demand = Willingness to pay Producer Price Q2* Q1* Quantity, Q

21. Question 10 • The government imposes a tax on all purchases of a good. In your supply-demand diagram where the price is the price received by sellers, what happens to the demand curve

22. Question 11 • The government imposes a tax on all purchases of a good. The supply of the good is completely inelastic. What happens to prices and quantities in the market? • Equilibrium price and quantity remain the same, but consumer price goes down. There is no “Harberger triangle”, the incidence of the tax is entirely born by producers.

23. Question 11 Price, P • Illustrate with steep supply curve Supply Curve Supply Curve plus tax Consumer Price Equilibrium price Demand = Willingness to pay Producer Price Q2* Q1* Quantity, Q

24. Question 11 • The steeper the supply curve, the bigger is the drop in the producer price relative to the increase in the consumer price. • Producers can not adjust quantity given their inelastic supply. • With perfectly inelastic supply the quantity does not adjust at all. So equilibrium quantity with a tax stay the same. The only way the equilibrium quantity can stay the same is that demand is unaffected by the tax – hence, the whole tax burden is paid by producers.

25. Question 11 Price, P • Imposing a tax on purchases (= shifting the demand curve down) • For a given price, consumers now get less quantity as the price they need to pay contains the tax per unit Supply Curve Equilibrium Price = Consumer Price Demand Producer Price Q1* Quantity, Q

26. Question 12-15 • Do on the Whiteboard

27. Discussion Question • Property prices are high in the UK and many people struggle to be able to afford to buy a house. In response to this the government launched in April 2013 the ‘Help to Buy’ Scheme that makes it easier for potential house buyers to finance the purchase of a house.

28. Effect on Demand and Supply • Using a demand and supply curve diagram show what you would expect the effect of the scheme to be on the demand and supply curves for housing • Draw a supply and demand curve • Demand curve shifts out (maybe more for relatively low priced housing as scheme geared for low income households) • Equilibrium quantity increases, prices go up.

29. Effect on Demand and Supply • Using a demand and supply curve diagram show what you would expect the effect of the scheme to be on the demand and supply curves for housing • Supply in short run likely to be fixed • Demand curve shifts out (maybe more for relatively low priced housing as scheme geared for low income households) • Equilibrium quantity increases, prices go up.

30. Effect on Demand and Supply

31. Effect on Demand and Supply • If the supply curve is very steep… • Demand shift does not change equilibrium quantity in any significant way. • But equilibrium prices increase – who benefits? • Current homeowners • Such a policy could has possible redistributive effects (from poor to rich).