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Elasticity and Its Application
5 Elasticity and Its Application
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Types of Demand Elasticities
Generally 3 categories we are concerned about Price elasticity Own-price: How quantity demanded changes with the (own) price Cross-price How quantity demanded changes with another (cross) good’s price changes Income How quantity demanded changes with a change in your income Want to be able to measure/estimate how much Qd when a factor that shifts Demand Curve Changes Also Measure Supply Elasticity how much Qs changes when a factor changes, e.g., input price -> min wage and labor costs
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Cross-Price and Income Factors That Shift the Demand Curve
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Own-Price (Demand) Elasiticity
Economist use the (own) price elasticity of demand to summarize how responsive quantity demanded is to price Demand curves are not always linear; and responsiveness can change with price
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The (own-price) Elasticity of Demand
Variety of demand curves: own-price (absolute value) Demand is elastic Elasticity > 1 => ΔQ/Q > ΔP/P raise price => ΔTot Rev < 0 Demand is inelastic Elasticity < 1 => ΔQ/Q < ΔP/P raise price => ΔTot Rev > 0 Demand has unit elasticity Elasticity = 1 => ΔQ/Q = ΔP/P => ΔTot Rev = 0
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Own-Price (Demand) Elasiticity
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The (own-price) Elasticity of Demand
Determinants of (own) price elasticity of demand Availability of close substitutes Goods with close substitutes More elastic demand Necessities vs. luxuries Necessities – inelastic demand Luxuries – elastic demand Definition of the market Narrowly defined markets – more elastic demand Time horizon More elastic over longer time horizons
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The Elasticity of Demand
Cigarettes (US)[41] -0.3 to -0.6 (General) -0.6 to -0.7 (Youth) – proportion of income? Soft drinks -0.8 to -1.0 (general)[51] (broadly defined) -3.8 (Coca-Cola)[52] (narrow) -4.4 (Mountain Dew)[52] (narrow) Car fuel[45] -0.25 (Short run) (same car – reduce trips) -0.64 (Long run) (new car?)
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Taxes How taxes on buyers affect market outcomes
Initial impact on the demand Demand curve shifts left Lower equilibrium price Lower equilibrium quantity The tax – reduces the size of the market
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7 A tax on buyers Price of Ice-Cream Cone Equilibrium with tax Price
D1 Equilibrium with tax Price buyers pay Supply, S1 Equilibrium without tax D2 $3.30 Price without tax Tax ($0.50) 90 A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). 3.00 100 2.80 Price sellers receive Quantity of Ice-Cream Cones When a tax of $0.50 is levied on buyers, the demand curve shifts down by $0.50 from D1 to D2. The equilibrium quantity falls from 100 to 90 cones. The price that sellers receive falls from $3.00 to $2.80. The price that buyers pay (including the tax) rises from $3.00 to $3.30. Even though the tax is levied on buyers, buyers and sellers share the burden of the tax.
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Impact of a payroll tax Wage Labor supply Wage firms pay
demand Wage firms pay Tax wedge Wage without tax Wage workers receive Quantity of Labor A payroll tax places a wedge between the wage that workers receive and the wage that firms pay. Comparing wages with and without the tax, you can see that workers and firms share the tax burden. This division of the tax burden between workers and firms does not depend on whether the government levies the tax on workers, levies the tax on firms,
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How the burden of a tax is divided (a)
9 How the burden of a tax is divided (a) (a) Elastic Supply, Inelastic Demand Price 1. When supply is more elastic than demand . . . Demand Supply Price buyers pay Tax The incidence of the tax falls more heavily on consumers . . . Price without tax Price sellers receive Than on producers. Quantity In panel (a), the supply curve is elastic, and the demand curve is inelastic. In this case, the price received by sellers falls only slightly, while the price paid by buyers rises substantially. Thus, buyers bear most of the burden of the tax.
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How the burden of a tax is divided (b)
9 How the burden of a tax is divided (b) (b) Inelastic Supply, Elastic Demand Price 1. When demand is more elastic than supply . . . Demand Supply Price buyers pay Tax 3. Than on consumers Price without tax The incidence of the tax falls more heavily on producers. Price sellers receive Quantity In panel (b), the supply curve is inelastic, and the demand curve is elastic. In this case, the price received by sellers falls substantially, while the price paid by buyers rises only slightly. Thus, sellers bear most of the burden of the tax.
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Taxes Tax burden - falls more heavily on the side of the market that is less elastic Small elasticity of demand Buyers do not have good alternatives to consuming this good Small elasticity of supply Sellers do not have good alternatives to producing this good
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Table 4.2 Factors That Shift the Supply Curve
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