Elasticity and its Applications Lecture Notes

This set of vocabulary flashcards covers key concepts of elasticity including PED, PES, YED, and XED, alongside their applications in market analysis, firm strategies, and government fiscal policy (taxes and subsidies).

Primary Product

A good that has not been processed and is in its natural state, specifically agricultural products like wheat and grains, or mining products like crude oil and iron ore.

Price Inelastic Demand

A situation where the price elasticity of demand (PED) is less than $1$ ($PED < 1$), meaning a rise in price leads to a less than proportionate fall in quantity demanded.

Price Inelastic Supply

A situation where the price elasticity of supply (PES) is less than $1$ ($PES < 1$), occurring when factors of production cannot be increased easily, such as land for wheat or oil reserves in the short run.

Normal Necessities

Goods with an income elasticity of demand (YED) between $0$ and $1$ ($0 < YED < 1$), where a fall in income results in a less than proportionate fall in demand.

Luxury Goods

Normal goods with an income elasticity of demand (YED) greater than $1$ ($YED > 1$), which see a significant rise in demand when the economy is doing well.

Inferior Goods

Goods with a negative income elasticity of demand ($YED < 0$), for which demand rises during an economic recession.

Substitutes

Related goods with a positive cross price elasticity of demand ($XED > 0$), where the closeness of the relationship is determined by the magnitude of the XED value.

Complements

Related goods with a negative cross price elasticity of demand ($XED < 0$), such as printers and ink cartridges.

Specific Tax

A type of indirect taxation levied as a fixed amount per unit sold (e.g., $\$0.50$ per litre of oil), causing a parallel leftward shift of the supply curve.

Ad Valorem Tax

A type of indirect taxation levied as a percentage of the selling price of the goods, such as a $3\%$ tax on the price of oil.

Consumer Surplus (Tax Impact)

The loss in welfare to consumers due to an indirect tax, represented by the area $P_2 cb P_1$ in market diagrams where price increases and quantity falls.

Producer Surplus (Tax Impact)

The loss in welfare to producers due to an indirect tax, represented by the area $P_1 bd P_0$, as they receive a lower price per unit.

Total Tax Revenue

The total amount collected by the government from an indirect tax, calculated as Tax per unit $\times$ units sold ($P_2 P_0 \times 0Q_2$).

Subsidy

A payment made by the government to producers to encourage production, which decreases the marginal cost of production and shifts the supply curve to the right.

Government Expenditure on Subsidy

The total cost to the government for providing a subsidy, calculated as Subsidy per unit $\times$ units sold ($P_0 P_2 \times 0Q_2$).

Sustainability of Subsidies

An evaluative consideration for governments when providing subsidies for goods with price elastic demand, as the necessary budget is significantly greater due to a more than proportionate increase in quantity demanded.