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]]Type of Elasticity]] | ]]Elasticity value]] |
---|---|
Perfectly inelastic | 0 |
Relatively Inelastic | <1 |
Unit elastic | 1 |
Relatively elastic | >1 |
Perfectly elastic | Infinity |
]]Type of Elasticity]] | ]]Relationship between Price and total revenue (TR)]] |
---|---|
Relatively elastic | inverse relation |
Relatively inelastic | direct relation |
Unit elastic | TR doesn’t change when P changes |
If the demand is perfectly elastic, the price elasticity is infinity
Any price above P1 and the demand falls to zero
Any price that’s exactly P1, the demand could keep increasing (buyers would buy as much quantity as possible)
Any price below P1 and the quantity demanded becomes infinite
If the demand is perfectly inelastic, the price elasticity of demand is zero
As the price keeps on changing, the quantity demanded stays same
A good example of this would be life-saving drugs
Prices could increase by a big margin but quantity demanded wouldn’t change still
This measure how the demand for a product changes with respect to change in their income
% change in quantity demanded/ %change in consumers income
Calculations of this help determine whether the product is inferior or normal good
Inferior good: as income increases, demand for the product decreases
Normal good: as income increases, demand for the product increases
This measures the change in supply that takes place with respect to changes in price
Time is key factor when looking at supply elasticity
The longer the firms have time to adjust, the more elastic the supply (difficult to adjust in the short term hence the inelasticity)
In the longer run, market supply is usually perfectly elastic
% change in quantity supplied / % change in price
If the demand curve is perfectly elastic, there wouldn’t be any consumer surplus
If the supply curve is perfectly elastic, there wouldn’t be any producer surplus
Assume the following demand is of tobacco
If a per-unit tax of T is imposed on the producers of cigarettes, the supply curve shifts upward by T
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Since quantity remained constant, the tax did nothing to decrease the harmful effects of smoking in society
Only increased tax revenues for the government
The entire tax was paid by consumers in the form of a new price exactly equal to the old price plus the tax.
Assume the following demand is of tobacco
The per-unit tax of T shifts the supply curve upward by T
Because the price of a pack of cigarettes did not increase after the tax, it was not the consumers who paid more
Producer pays the entire share of the tax when demand is perfectly elastic
Compared to the perfectly inelastic scenario, the government collected much fewer tax revenue dollars
Maximum decrease in harmful cigarette consumption is a definite plus
A perfectly elastic, or horizontal, supply curve tells us that even a very small change in the price will cause an infinitely large change in the quantity supplied
The new equilibrium price is exactly T higher than the old price P0, so consumers pay the entire burden of the tax
The equilibrium quantity decreases from Q0 to Q1, and the government collects tax revenue equal to T × Q1.
A perfectly inelastic, or vertical, supply curve illustrates the special case where any change in the price creates absolutely no change in the quantity supplied
At the equilibrium quantity Q0, suppliers would like to charge a higher price than P0, but any price above P0 creates a surplus, and this surplus will clear only at the equilibrium price P0.
The firms must pay T to the government for each of the Q0 units that are sold and consumers continue to pay the original price of P0
Producers pay the entire burden of the tax because, after paying the tax, they receive only (P0 – T) on each unit
]]Price elasticity of supply]] | ]]Government revenue]] | ]]Decrease in consumption]] | ]]Incidence of tax paid by consumers]] | ]]Incidence of tax paid by product]] |
---|---|---|---|---|
infinity | the least | the most | 100% | 0% |
>1 | falling | sizeable | >50% | <50% |
<1 | rising | minimal | <50% | >50% |
0 | the most | 0 | 0% | 100% |
There is also a cost to society when an excise tax is imposed on a competitive market
With the tax, consumers and producers demand and supply 20 fewer units than without the tax
For these 20 units that go unproduced, the marginal benefit to consumers exceeds the marginal costs to producers
20 units go unproduced and unconsumed resulting in an inefficient outcome
Economists call this area deadweight loss (DWL), or the net benefit sacrificed by society when such a per-unit tax is imposed (triangle labeled DWL)
Taxes create lost efficiency by moving away from the equilibrium market quantity where MB = MC to society.
The area of deadweight loss (triangle DWL) increases as the quantity moves further from the competitive market equilibrium quantity
A per-unit subsidy on good X has the opposite effect of an excise tax
Firms respond as if the subsidy has lowered the marginal cost of production
Results in a downward vertical shift in the supply curve for good X
Assume the graph of the market for public university education
The subsidy decreases tuition to P1 and increases the number of undergraduate degrees received
Subsidy distorts the market and creates deadweight loss
Deadweight loss is the area of the triangle labeled DWL.
A price floor is a legal minimum price below which the product cannot be sold
An ineffective price floor would be a price set below the equilibrium price
Assume this to be a market for milk
The resulting surplus of milk is not eliminated through the market
The government usually agrees, as part of the price floor arrangement, to purchase the surplus milk
By providing an incentive for producers to produce beyond where MB = MC, the price floor policy causes efficiency to be lost.
For gallons of milk above Q0, MC > MB; there is an over allocation of resources to milk production
A price ceiling is a legal maximum price above which the product cannot be bought and sold
An effective price ceiling must be set below the equilibrium price
Assume this to be a market for rent-controlled households
This form of price control results in lost efficiency for society
When suppliers reduce their quantity supplied below the competitive equilibrium quantity, there is a situation where MB > MC, and we see under allocation of resources in the rental apartment market
Revenue tariff is an excise tax levied on goods that are not produced in the domestic market.
Protective tariff is an excise tax levied on a good that is produced in the domestic market
Consumers pay higher prices and consume less
Consumer surplus has been lost
Domestic producers increase output
Declining imports
Tariff revenue
Inefficiency
Deadweight loss
Total utility initially rises, peaks, and then begins to fall as more coffee is consumed(see fig above)
Even if the monetary price of good X is zero, the rational consumer stops consuming good X at the point where total utility is maximized.
]]Cups of coffee]] | ]]MU of coffee]] | ]]# of Scones]] | ]]MU of Scone]] |
---|---|---|---|
1 | 10 | 1 | 30 |
2 | 8 | 2 | 24 |
3 | 6 | 3 | 20 |
4 | 4 | 4 | 16 |
5 | 2 | 5 | 14 |
6 | 1 | 6 | 8 |
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