1. 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

2. 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

3. 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

4. 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

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. Perfectly Inelastic DemandQ
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

14. 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

15. ¸ 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

16. Price Elasticity of Demand and Revenue5
Price Elasticity of
Demand and Revenue 4
Ed > 1
Price (per unit) 3 2 1 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
Units of X (thousands per week)

17. Price Elasticity of Demand and Revenue Price Elasticity of5
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 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
3–17
Units of X (thousands per week)
Units of X (thousands per week)

18. Price Elasticity of Demand and Revenue Price Elasticity of5 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 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
Units of X (thousands per week)
Units of X (thousands per week)
Units of X (thousands per week)
Units of X (thousands per week)

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. 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

27. 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

28. 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

29. Legal Prices: Price CeilingsD 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

30. 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

31. 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

32. 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

33. 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

34. 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

35. Incidence of a Sales TaxP 5 4 3 2 1
Price ($ per bottle) D S Q
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

36. Incidence of a Sales Tax (cont.)P
Tax $1 5 4 3 2 1
Price ($ per bottle) S1 D S Q
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

37. 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
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

38. Elastic Demand & IncidenceP
Tax $1 5 4 3 2 1
Consumer’s tax
incidence
Price ($ per bottle) D S1
Producer’s tax
incidence S Q
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

39. Inelastic Demand & IncidenceP
Tax $1 5 4 3 2 1
Consumer’s tax
incidence
Producer’s tax
incidence
Price ($ per bottle) S1 S D Q
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

40. 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

41. 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

42. Economic Impact of TariffsSd 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

43. 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

44. 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

45. Economic Impact of QuotasSd 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

46. 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

47. 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