Chapter 3 Taxes, Price Controls and Trade Applications Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Learning Objectives Introduce the concept of price elasticity of demand and discuss its determinants. Relate price elasticity of demand to the changes in total revenue that result from a change in market price. Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Learning Objectives (cont.) Introduce the concept of the elasticity of supply and its relationship to time. Define the cross-price and income elasticities of demand. Survey some applications of supply and demand analysis. Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Learning Objectives (cont.) Describe the most common forms of trade barriers used to provide protection to local industry. Examine the consequence of trade barriers for achieving the goal of economic efficiency, using the examples of tariffs and quotas. Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity of Demand The price elasticity of demand is the measure of the responsiveness of the quantity demanded to a change in price of a product Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity is... P D Q P2 P1 Q2 Q1 As price increases from P1 to P2, quantity decreases from Q1 to Q2 P2 P1 D Q Q2 Q1 Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity is... (cont.) As price decreases from P1 to P2, quantity increases from Q1 to Q2 P1 P2 D Q1 Q2 Q Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity is... (cont.) But what percentage did price change and what percentage did quantity change? P2 P1 D Q2 Q1 Q Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Formula for Elasticity The percentage change in price The percentage change in quantity Ed = Ed = Change in quantity price Original ÷ Original quantity demanded Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity of Demand Use of percentages choice of units product comparison Ignore the minus sign the absolute value of the coefficient is what is important Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity of Demand (cont.) Elastic Demand—a given percentage change in price results in a larger percentage change in quantity demanded Ed > 1 Inelastic Demand—a given percentage change in price results in a relatively smaller percentage change in quantity demanded Ed < 1 Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity of Demand (cont.) Unit elasticity a given percentage change in price results in an equal percentage change in quantity demanded Ed = 1 Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Perfectly Inelastic Demand Q Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Perfectly Elastic Demand inelastic demand D2 Perfectly elastic demand Q Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
¸ Midpoints Formula Change in quantity Change in price Ed = Sum of Quantities/2 Sum of prices/2 Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity of Demand and Revenue 5 Price Elasticity of Demand and Revenue 4 Ed > 1 Price (per unit) 3 2 1 0 2 4 6 8 10 12 14 16 20 16 TR Total Revenue 12 8 4 Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University 3–16 0 2 4 6 8 10 12 14 16 Units of X (thousands per week)
Price Elasticity of Demand and Revenue Price Elasticity of 5 Price Elasticity of Demand and Revenue Price Elasticity of Demand and Revenue 5 4 4 Ed > 1 Ed > 1 Price (per unit) Price (per unit) 3 3 Ed = 1 Ed = 1 2 2 1 1 0 2 4 6 7 8 10 12 14 0 2 4 6 8 10 12 14 16 20 20 16 16 TR Total Revenue Total Revenue 12 12 8 8 4 4 Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University 17 0 2 4 6 7 8 10 12 14 0 2 4 6 8 10 12 14 16 3–17 Units of X (thousands per week) Units of X (thousands per week)
Price Elasticity of Demand and Revenue Price Elasticity of 5 5 5 Price Elasticity of Demand and Revenue Price Elasticity of Demand and Revenue Price Elasticity of Demand and Revenue Price Elasticity of Demand and Revenue 5 4 4 4 4 Ed > 1 Ed > 1 Ed > 1 Ed > 1 Price (per unit) Price (per unit) Price (per unit) Price (per unit) 3 3 3 3 Ed = 1 Ed = 1 Ed = 1 2 2 2 2 Ed < 1 Ed < 1 Ed < 1 1 1 1 1 0 2 4 6 7 8 10 12 14 0 2 4 6 8 10 12 14 16 0 2 4 6 7 8 10 12 14 0 2 4 6 8 10 12 14 16 20 20 20 20 16 16 16 16 TR TR TR Total Revenue Total Revenue Total Revenue Total Revenue 12 12 12 12 8 8 8 8 4 4 4 4 Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University 3–18 18 18 18 0 2 4 6 7 8 10 12 14 0 2 4 6 8 10 12 14 16 0 2 4 6 7 8 10 12 14 0 2 4 6 8 10 12 14 16 Units of X (thousands per week) Units of X (thousands per week) Units of X (thousands per week) Units of X (thousands per week)
Total Revenue Test Elastic demand Inelastic demand Unit elasticity a change in price will cause total revenue to change in the opposite direction Inelastic demand a change in price will cause total revenue to change in the same direction Unit elasticity a change in price leaves total revenue unchanged Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Determinants of Price Elasticity of Demand Substitutability Proportion of income Luxuries versus necessities Time Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Elasticity of Demand: Some Applications Bumper crops Automation Excise taxes Heroin and crime Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity of Supply Percentage change in quantity supplied of product X Es = Percentage change in the price of product X Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity of Supply (cont.) Sm D2 Immediate market period D1 Pm Po D1 Q Qo Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity of Supply (cont.) Ss Short run D2 Ps Po D1 Q Qo Qs Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Elasticity of Supply (cont.) D2 Long run SL PL Po S′L D1 Qo Q Qo QL Q′L Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Cross Elasticity of Demand Percentage change in quantity demanded of good X Exy = Percentage change in the price of good Y Substitute goods—Positive sign Complementary goods—Negative sign Independent goods—Zero or near-zero value Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Income Elasticity of Demand Percentage change in quantity demanded Ei = Percentage change in income Normal goods—Positive sign Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Income Elasticity of Demand (cont.) Percentage change in quantity demanded Ei = Percentage change in income Normal goods—Positive sign Inferior goods—Negative sign Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Legal Prices: Price Ceilings D S The result of imposing a legal price ceiling is a... P S D Q Qs Qe Qd Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Ceilings (cont.) P D S P Legal Price Ceiling Pc S D Q Qs Qe Qd Shortage D Q Qs Qe Qd Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Ceilings and Shortages Price ceiling is the maximum legal price a seller may charge for a product or service. Price ceilings result in shortages: Wartime price controls Rationing problem Black market Rent controls Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Supports and Surpluses Price support or ‘price floor’ is a minimum price fixed by government, above equilibrium prices Minimum wage legislation Agricultural support prices Price support results in surpluses Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Price Supports and Surpluses (cont.) Qs Qd Legal Price Support Ps Pe S D Q Q Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Elasticity and Tax Incidence Elasticity of demand and supply determines who bears the burden of sales or excise tax, called the incidence of a tax. Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Incidence of a Sales Tax P 5 4 3 2 1 Price ($ per bottle) D S Q 5 10 15 20 25 30 35 40 Quantity demanded (thousands of bottles/month) Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Incidence of a Sales Tax (cont.) P Tax $1 5 4 3 2 1 Price ($ per bottle) S1 D S Q 5 10 15 20 25 30 35 40 Quantity demanded (thousands of bottles/month) Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Incidence of a Sales Tax (cont.) P Tax $1 5 4 3 2 1 Consumer’s tax incidence Producer’s tax incidence Price ($ per bottle) S1 D S Q 5 10 15 20 25 30 35 40 Quantity demanded (thousands of bottles/month) Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Elastic Demand & Incidence P Tax $1 5 4 3 2 1 Consumer’s tax incidence Price ($ per bottle) D S1 Producer’s tax incidence S Q 5 10 15 20 25 30 35 40 Quantity demanded (thousands of bottles/month) Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Inelastic Demand & Incidence P Tax $1 5 4 3 2 1 Consumer’s tax incidence Producer’s tax incidence Price ($ per bottle) S1 S D Q 5 10 15 20 25 30 35 40 Quantity demanded (thousands of bottles/month) Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Barriers to Trade Tariffs Import quotas excise taxes on imported goods can be either revenue tariffs or protective tariffs Import quotas restrictions on the amount of foreign product imported over a specific period zero quota indicates complete prohibition Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Barriers to Trade (Cont.) Non-tariff barriers (NTBs) licensing standards or procedures designed with the primary purpose of protecting local production against foreign competition Voluntary export restrictions (VERs) negotiated restrictions on the level of exports to a particular country Motivations: special-interest effect need to protect the interest of special groups, like Australian clothing industry Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Economic Impact of Tariffs Sd D Pd g f h i Price Sw + t Pt e j Pw Sw Quantity a b q c d Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Economic Impact of Tariffs (cont.) Consumption loss a measure of the benefit lost to consumers that is not captured by other elements in society Production loss the value of production lost to society Deadweight loss the reduction in the total level of welfare (or real incomes) across society due to tariff protection Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Economic Impact of Tariffs (cont.) Effects on foreign producers income of foreign producers will fall Government revenue the government gains by obtaining tariff revenue tariff revenue is essentially a transfer of income from consumers to government and does not represent any net change in the nation’s economic wellbeing Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Economic Impact of Quotas Sd Pd f i Price PQ e j g h Pw Sw Dd Quantity a b q c d Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Tariffs vs Quotas Tariffs distort the operation of the price mechanism, but demand and supply still determine the quantity of imports Quotas are more restrictive and break the link between domestic and foreign prices completely Tariffs provide revenue to the government, while quota rents accrue to the protected industry Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University
Next Chapter: Consumer Behaviour Copyright 2004 McGraw-Hill Australia Pty Ltd PPTs t/a Economic Principles by Jackson, McIver, Bajada and Hettihewa Slides prepared by Muni Perumal, University of Canberra and Jay Bandaralage, Griffith University