Elasticity/tax/subsidy test

YED

Income elasticity of demand

What is elasticity for?

see change of responsiveness when change of one determinant.

Def of PED?

Measure of responsiveness (change in QD) of consumers when there is a price change.

IF PED =0

Change in price of product doesn’t affect QD.

If less than 1

Inelastic

More than 1

elastic

What is unit elastic demand?

% change in QD= % change in P

Determinants of PED

• Substitutes (number and closeness)

• Necessity?

• proportion of income spent on good

• Time period considered (takes time to change habits, in long run more elastic)

PED is good knowledge for firms because:

Predicting effects on pricing decisions on QD and TR

PED is good knowledge for govt because:

know possible consequences of imposing indirect tax

primary commodities aka

raw materials

primary commodities have …. demand

inelastic (neccesity)

PED of manufactured goods tend to be:

elastic because of substitutes.

What does YED measure?

measures how much demand for a product changes when there is a change in consumer income.

The sign of YED (+ or -) shows if the goods are

normal (+) or inferior (-)

Superior goods (YED)

If income rises, necessities are done so they start purchasing wants.

Subsidy

The specific amount of money given by the govt to producers, reducing costs per unit.

PES

measure of how much supply changes of a product when there is a change in price.

Determinants of PES

Time

mobility of FOP’s

unused capacity

How much costs rise as output increases

PES of primary commodities

inelastic supply, because cant lead to proportional change in supply due to having to move resources and other stuff like plantation.

PES of manufactured goods:

elastic, easier increase/decrease QS

Why are indirect taxes used?

provide gov revenue. Discourage consumption.

Why does indirect tax shift S curve?

It raises the firm’s cost by amount of tax.

What are 2 types of indirect tax?

Specific tax andAd valorem tax

WHat is specific tax?

Specific/fixed amount of tax imposed upon product. Supply curve shifts to left by this given amount.

What is Ad Valorem tax?

A percentage tax on the selling price. Tax bigger as product rises. Could be a 20% tax.

IF PED=PES burden is

shared

If PED>PES (tax burden)

mostly producer tax burden

If PES> PED (tax burden)

mostly consumer tax burden

Why are tax imposed on relatively inelastic products?

Change in QD is small, gov revenue is high and barely no fall in employment.

Def of subsidy:

Specific amount of money governments give to firms to reduce costs per unit.

Reasons for subsidys:

• lower price of necessity goods

• guarantee supply of products govt think are a necessity

• Enable producers to compete with overseas trade, protecting home industry.

law of diminishing marginal utility:

As consumption increases satisfaction decreases

law of diminishing marginal returns:

output from each additional unit of the variable factor will eventually diminish.

What are the 2 ways to impose price control?

min (floor) pricing and max (ceiling pricing)

What does price ceiling do?

Situation where govt puts a price max below equilibrium price. Usually to help consumers with necessity/merit goods

Problems of price ceiling?

• May lead to shortage (black market selling)

how can govt shift s curve to right (price ceiling)?

• Govt can offer subsidy to firms - encourage to produce more.

• Govt could start supplying the product. Causing supply to increase (direct provision).

• If govt previously stored some of the product, could release some of the stock.

What does price flooring do?

situation where govt creates min price above equilibrium price.

what are the 2 main reasons price ceiling is set for?

• Attempt to raise income for producers of good/service (maybe due to foreign comp).

• Protect workers by setting min wage - ensuring workers make enough. (equity)

What is the problem with price flooring?

QD decreases become price is higher, so there is surplus. Govt buys extra supply at low price, shifting demand curve to the right.

how can min price can be obtained?

govt could try increase demand through advertising product or restricting supply.

min price can help consumers make:

better choices

why govt intervene in markets

1. help consumers make better choices

2. promote sustainability

3. promote equity and economic well being