1. Determinants of Elasticity
Availability of substitutes
Necessities vs. Luxuries
Importance in the Buyer’s Budget
Time Horizon
The demand is more price elastic:
close substitutes are easy to find
The less of a “necessity” (luxurious)
The more of total budgets spent on good
The longer the time horizon

2. Two Practical Examples
Elasticity and Mass Transit
long-run demand for mass transit is inelastic
An increase in fares
would increase revenue
would decrease ridership
Elasticity and an Oil Crisis
to bring about 1% percent decrease in world oil demand
oil prices would have to rise by 6.67%

3. Income Elasticity of Demand
Percentage change in quantity demanded divided by the percentage change in income
percentage increase in quantity demanded for each 1% rise in income

4. Income Elasticity of Demand
Differences
Price elasticity of Demand
sensitivity of demand to price as we move along a demand curve
virtually always negative
Income elasticity of Demand
relative shift in demand curve
positive or negative

5. Cross-Price Elasticity of Demand
Percentage change in quantity demanded of one good (x) caused by a 1% change in the price of another good (y)
Substitutes: Exy >0
Complements: Exy <0

6. Price Elasticity of Supply
Percentage change in quantity of a good supplied, caused by a 1% change in the price of the good
The more easily suppliers can switch from/to alternate goods, the more elastic the supply

7. Taxes and Market Equilibrium
Excise tax - tax on a specific good
to raise the price and discourage the use
A tax collected from sellers
shifts the supply curve upward by the amount of the tax
A tax collected from buyers
shifts the demand curve downward

8. An Excise Tax on Sellers - Airlines
Figure 7 A Tax on Sellers Shifts the Supply Curve Upward
SAfter Tax
Price per
Ticket S1
$360 A’
with a $60 tax, the
airlines must get $60 more
than before to supply any
given number of tickets.
300 A 10
Millions of
Tickets per Year

9. An Excise Tax on Sellers - Airlines
Figure 8 The Effect of an Excise Tax Imposed on Sellers
Price per
Ticket
After the tax
Buyers pay $40 of the tax
Sellers pay $20 of the tax
Safter tax
$360
340 B S1
300 A
Before the tax D
7.5 10
Millions of
Tickets per Year

10. An Excise Tax on Buyers
Figure 9 A Tax on Buyers Shifts the Demand Curve Downward
with a $60 tax imposed on buyers
they must be charged $60 less
than before to demand any
given number of tickets.
Price per
Ticket A
$300 A’
240 D1
D After Tax 10
Millions of
Tickets per Year

11. An Excise Tax on Buyers
Figure 10 The Effect of an Excise Tax Imposed on Buyers
Price per
Ticket
Buyers pay $40 of the tax
Sellers pay $20 of the tax S
$340
$340 A
Before the tax
300
280
280 C
After the tax D1
D After Tax
7.5 10
Millions of
Tickets per Year

12. Incidence of tax
The incidence of a tax is the same no matter the tax is imposed on buyers or imposed on sellers
The incidence of a tax depends on the elasticity of demand and supply.
The more elastic side will take less of the tax burden, and vice versa
Because the elastic side has more options. (switch to substitute or alternative good)

13. The War on Drugs
Figure 11(a) - Market for drug without government intervention
Figure 11(b) - Result of government efforts to restrict supply (current policy)
Price rises;
Total expenditure increases
Figure 11(c) - Results of an effective policy of reducing demand
Price falls;
Total expenditure falls

14. The War on Drugs Figure 11a The War on Drugs Price per Unit S1 A P1 D1
Quantity
Price per Unit S1 A P1 D1 Q1

15. The War on Drugs Figure 11b The War on Drugs Quantity Price per Unit

16. The War on Drugs Figure 11c The War on Drugs Quantity Price per Unit