Microeconomics, Chapter 4: Elasticity, + taxation

Elasticity

Sensibility analysis

Price elasticity of demand

How much does quantity demanded change due to a price change?

• elastic

  • sensitive to price change

• inelastic

  • not sensitive to price change

Formula:

• change in % Gd / change in % price

• (change in Qd / Average Qd) / (change in p / average p)

Elastic demand

• Sensitive to price change

• n>1 (larger than one)

• %change in Qd > %change in P

• narrowly defined products

• expensive items

Inelastic

• not sensitive to price change

• n<1 (smaller than one)

• %change in P > %change in Qd

• necessities

absolute change

final price - initial price

• by how many units did the variable change?

Relative Change

• compare change in different contexts

• compare change in different initial values

• % change

what determines elasticity of demand?

• short and long run

  • short run = inelastic

  • long run = elastic

• importance in consumer budget

  • more portion of budget = inelastic

  • less portion of budget = elastic

• availability of substitutes

  • more substitutes = elastic

  • less substitutes = inelastic

inelastic demand graph

steeper

elastic demand graph

flatter

is elasticity constant along a linear demand curve?

no, it is changing.

• the further down the curve, the lower the elasticity

perfectly elastic demand

n = INFINITY

%change in Qd > %change in P

perfectly inelastic demand

n = 0

%change in Qd < %change in P

unit elastic

n = 1

%change in Qd = %change in P

price elasticity of supply

sensitivity of supply to price shocks

determinants of elasticity of supply

• ease of substitution

  • decrease in price of one item → how easy is it to shift production away from that item?

• short run vs. long run

  • long run = elastic

  • short run = inelastic

excise taxes

tax on a particular product, shared between consumer and producer depending on elasticity

Tax incidence

measure of WHO IS PAYING THE TAX - consumer or producer?

how to determine the price of a tax from the graph

NOT space between equilibrium

SPACE BETWEEN SUPPLY CURVE 1 AND EQUILIBRIUM OF SUPPLY CURVE TWO ON THE Y AXIS

dead weight loss

the surplus lost from implementing a excise tax

• DECREASE IN TOTAL SURPLUS

• DECREASE IN TOTAL EFFICIENCY

Who pays the tax depending on elasticity?

Unit elastic : tax shared equally

perfectly inelastic: consumer pays

perfectly elastic : producer pays

tax = difference between which prices?

difference between consumer and producer prices = tax

is new equilibrium quantity exchanged more or less compared to without tax?

tax = quantity exchanged is less in new equilibrium

total expenditure

The sum of the price paid for one or more products or services multiplied by the amount of each item purchased.

expenditure depends on elasticity of demand

where is highest expenditure in terms of elasticity?

Unit elastic

total expenditure in terms of elastic demand

higher price = lower total expenditure

lower price = higher total expenditure

inverse relationship between total expenditure and price for ELASTIC demand

total expenditure in terms of inelastic demand

higher price = higher expenditure

lower price = lower expenditure

positive relationship between total expenditure and inelastic demand

Income elasticity of demand

ny = (%change in Qd) / (%change in income)

• necessities versus luxuries (+)

• normal and inferior goods (+), (-)

normal goods

• positive income elasticity

• increase in income = increase in demand

• the more necessary an item the lower its income elasticity

• luxuries

  • elastic ny>1 (bigger than one)

• necessities

  • inelastic - ny<1 (smaller than one)

inferior goods

negative income elasticity

• the higher the income, the decrease in demand

• mr noodles! - the more income i have, i’m buying way better pasta then mr noodles

Cross elasticity of demand

responsiveness of Qd to the price of a DIFFERENT product

• (%change in Qd of good X) / (%change in Qd of good Y) = nxy

• complimentary versus substitutes

• higher elasticity = higher competition

higher cross elasticity of demand = ______ competition

higher competition (cause of substitutes)

substitute goods in cross elasticity of demand

(-) cross elasticity

• increase price of gas = decrease demand of cars

  • more competition

complimentary goods in cross elasticity of demand

(+) cross elasticity

• increase price of cars = increase demand in public transport