Question

Demand elasticity and social loss. Consider two vaccines for different viruses ? and ?. Assume that the marginal cost of producing both drugs is constant and that the fixed cost is small. In other words, assume that the supply curve for both drugs is flat (horizontal).

Market for Vaccine ? Market for Vaccine ?

Suppose that demand for vaccine ? is price elastic, whereas demand for vaccine ? is relatively inelastic. Using the graphs above, draw two demand curves: one corresponding to the elastic demand for vaccine ? and one corresponding to the inelastic demand for vaccine ?. On each graph, label the demand curve DPRIVATE and the market vaccination rate Q*PRIVATE.

THINK: The price elasticity of demand is related to the slope of the demand curve. How should the slope of the

(elastic) demand curve for vaccine ? compare to the slope of the (inelastic) demand curve for vaccine ??

For the sake of this example, assume that vaccine ? and vaccine ? have exactly the same (positive) externality.

Draw a social demand curve for vaccine ? and for vaccine ?. On each graph, label the social demand curve DSOCIAL and the socially optimal vaccination rate Q*SOCIAL.

THINK: In the case of a positive externality, the social demand curve will be shifted above (but parallel to) the private demand curve. How is the size of this shift (exactly how far DSOCIAL is drawn above DPRIVATE) related to the size of the externality?

On each graph, shade in and label the area corresponding to social loss. Explain intuitively why, all else equal, social loss is greater in the case of elastic demand than it is in the case of inelastic demand.

Answer 1