1. Elasticities of Demand and Supply1 ELASTICITIES OF DEMAND AND SUPPLY ECO 2023 Principles of Microeconomics Dr. McCaleb

2. Elasticities of Demand and Supply2 TOPIC OUTLINE I.Price Elasticity of Demand II.Application: Elasticity and the Demand for Smoking III.Price Elasticity of Supply IV.Cross Elasticity and Income Elasticity V.Application: Tax Incidence and Efficiency

3. Elasticities of Demand and Supply3 Price Elasticity of Demand

4. Elasticities of Demand and Supply4 PRICE ELASTICITY OF DEMAND  Price Elasticity of Demand Definition The price elasticity of demand is the ratio of the percentage change in the quantity demanded to the percentage change in price. It is a measure of the extent to which the quantity demanded of a good changes when the price of the good changes.

5. Elasticities of Demand and Supply5 PRICE ELASTICITY OF DEMAND  Calculating the Price Elasticity of Demand Problem Suppose Starbucks raises the price of a latte from $3 to $5 a cup. The price increase is 66.67 percent of the initial $3 price. Now, suppose Starbucks lowers the price from $5 to $3. The price decrease is 40 percent of the initial $5 price. The same price change, $2, over the same interval, $3 to $5, is a different percentage change depending on whether the price rises or falls.

6. Elasticities of Demand and Supply6 PRICE ELASTICITY OF DEMAND  Calculating the Price Elasticity of Demand Solution We need a measure of percentage change that does not depend on the direction of the price change. We use the average of the initial price and the new price to measure the percentage change in price. Similarly, we use the average of the initial quantity and the new quantity to measure the percentage change in quantity. This is called the midpoint method for computing the elasticity.

7. Elasticities of Demand and Supply7 PRICE ELASTICITY OF DEMAND  The Midpoint Method Calculating the percentage change in quantity demanded To calculate the percentage change in quantity demanded divide the change in the quantity demanded by the average quantity demanded and then multiply by 100. The average quantity demanded is at the midpoint between the initial quantity and the new quantity.

8. Elasticities of Demand and Supply8 PRICE ELASTICITY OF DEMAND  The Midpoint Method Calculating the percentage change in price To calculate the percentage change in price, divide the change in the price by the average price and then multiply by 100. The average price is at the midpoint between the initial price and the new price.

9. Elasticities of Demand and Supply9 PRICE ELASTICITY OF DEMAND The price elasticity of demand equals 100% divided by 50%, or 2. The quantity decrease is 100% of the average quantity. Calculating Demand Elasticity: Example If Starbucks raises the price of a latte from $3 to $5 a cup, the quantity demanded decreases from 15 to 5 cups per hour. The price increase is 50% of the average price.

10. Elasticities of Demand and Supply10 PRICE ELASTICITY OF DEMAND  Comment Minus sign Because of the Law of Demand, when the price rises, the quantity demanded decreases. Price and quantity demanded always change in opposite directions. Therefore, the elasticity of demand calculated by the midpoint formula is always negative. So we ignore the minus sign and use absolute values.

11. Elasticities of Demand and Supply11 PRICE ELASTICITY OF DEMAND  Elastic and Inelastic Demand Based on the coefficient of elasticity, the demand for any good can be classified into one of five categories Elastic Unit elastic Inelastic Perfectly elastic Perfectly inelastic

12. Elasticities of Demand and Supply12 PRICE ELASTICITY OF DEMAND  Elastic and Inelastic Demand Demand is elastic if the percentage change in quantity demanded is greater than the percentage change in price the coefficient of the elasticity of demand is greater than 1.

13. Elasticities of Demand and Supply13 PRICE ELASTICITY OF DEMAND When the price of a Sony Playstation rises by 10%,... the quantity demanded decreases by 20%. The decrease in quantity demanded is greater than the increase in price. Therefore, demand for Sony Playstations is elastic. Elastic Demand

14. Elasticities of Demand and Supply14 PRICE ELASTICITY OF DEMAND  Elastic and Inelastic Demand Demand is unit elastic if the percentage change in quantity demanded is the same as the percentage change in price the coefficient of the elasticity of demand equals 1.

15. Elasticities of Demand and Supply15 PRICE ELASTICITY OF DEMAND When the price of a trip rises by 10%,... the quantity demanded of trips decreases by 10%. The decrease in quantity demanded is the same as the increase in price. Therefore, the demand for trips is unit elastic. Unit Elastic Demand

16. Elasticities of Demand and Supply16 PRICE ELASTICITY OF DEMAND  Elastic and Inelastic Demand Demand is inelastic if the percentage change in quantity demanded is smaller than the percentage change in price the coefficient of the elasticity of demand is less than 1.

17. Elasticities of Demand and Supply17 PRICE ELASTICITY OF DEMAND When the price of gum rises by 20%,... the quantity demanded decreases by 10%. The decrease in quantity demanded is smaller than the increase in price. Therefore, the demand for gum is inelastic. Inelastic Demand

18. Elasticities of Demand and Supply18 PRICE ELASTICITY OF DEMAND  Elastic and Inelastic Demand Demand is perfectly elastic if the quantity demanded changes by a very large percentage in response to an almost zero percentage change in price. the coefficient of the elasticity of demand is infinite (the numerator is very large and the denominator is infinitesimally small).

19. Elasticities of Demand and Supply19 PRICE ELASTICITY OF DEMAND For even a very small change in the price of spring water,... the quantity demanded of spring water changes by a very large amount. The change in the quantity demanded is much (infinitely) larger than the change in price. Therefore, the demand for spring water is perfectly elastic. Special Case: Perfectly Elastic Demand

20. Elasticities of Demand and Supply20 PRICE ELASTICITY OF DEMAND  Elastic and Inelastic Demand Demand is perfectly inelastic if the percentage change in quantity demanded is zero when the price changes. the coefficient of the elasticity of demand equals 0.

21. Elasticities of Demand and Supply21 PRICE ELASTICITY OF DEMAND When the price rises,... the quantity demanded does not change. There is no change in the quantity demanded when price changes. Therefore, demand is perfectly inelastic. Special Case: Perfectly Inelastic Demand

22. Elasticities of Demand and Supply22 PRICE ELASTICITY OF DEMAND  Comments Elasticity is independent of units of measurement Elasticity is independent of the units used to measure price and quantity. Because it is the ratio of two percentages, it is a number with no units. For example, the elasticity of demand for latte is simply 2. Elasticity allows us to compare the demands for different goods. For example, we can compare the elasticity of demand for latte with the elasticity of demand for baseball tickets.

23. Elasticities of Demand and Supply23 PRICE ELASTICITY OF DEMAND  Comments Elasticity is not the same as slope Unlike elasticity, slope depends on the units of measurement of price and quantity. For example, the slope of the demand curve for latte has the units “dollars per cup”. Slope cannot be used to compare the demands for different goods because the slopes have different units.

24. Elasticities of Demand and Supply24 PRICE ELASTICITY OF DEMAND At any price above the midpoint, demand is elastic. At any price below the midpoint, demand is inelastic. At the midpoint, demand is unit elastic. Elasticity and Slope: Example Along a linear (straight-line) demand curve, the slope is constant but the elasticity decreases as the price falls.

25. Elasticities of Demand and Supply25 PRICE ELASTICITY OF DEMAND  Variables That Influence the Price Elasticity of Demand Influences on the price elasticity of demand include Substitution effects Time Income effects

26. Elasticities of Demand and Supply26 PRICE ELASTICITY OF DEMAND  Variables That Influence the Price Elasticity of Demand Substitution effects If a substitute for a good is easy to find, then ceteris paribus, the demand for the good tends to be more elastic or less inelastic. If a substitute for a good is hard to find, then ceteris paribus, the demand for the good tends to be more inelastic or less elastic.

27. Elasticities of Demand and Supply27 PRICE ELASTICITY OF DEMAND  Variables That Influence the Price Elasticity of Demand Time As time passes after a price change, consumers find it easier to make substitutions among goods. Therefore, the longer the time elapsed since the price change, ceteris paribus, the more elastic is the demand for the good.

28. Elasticities of Demand and Supply28 PRICE ELASTICITY OF DEMAND  Variables That Influence the Price Elasticity of Demand Income Effects The greater the proportion of income spent on a good, ceteris paribus, the more elastic is the demand for the good. The smaller the proportion of income spent on a good, ceteris paribus, the more inelastic is the demand for the good.

29. Elasticities of Demand and Supply29 PRICE ELASTICITY OF DEMAND  Total Revenue and Price Elasticity of Demand Total revenue or total expenditure The amount spent on a good by consumers and received by sellers. It equals the price of the good multiplied by the quantity of the good sold: TR(or TE) = P x Q. Total revenue and total expenditure are the same thing. The amount received by sellers is the same as the amount spent by buyers.

30. Elasticities of Demand and Supply30 PRICE ELASTICITY OF DEMAND  Total Revenue and Price Elasticity of Demand Relationship between price elasticity of demand and total revenue There is a unique relationship between the price elasticity of demand and total revenue (or total expenditure). This relationship is valid for the price elasticity of demand only. It is not valid for any other elasticity (income elasticity of demand, price elasticity of supply, or cross-elasticities).

31. Elasticities of Demand and Supply31 PRICE ELASTICITY OF DEMAND  Total Revenue and Price Elasticity of Demand Elastic demand Total revenue changes in the opposite direction to price. When price increases, the percentage decrease in quantity demanded is larger than the percentage increase in price. Therefore, total revenue decreases. When price decreases, the percentage increase in quantity demanded is larger than the percentage decrease in price. Therefore, total revenue increases.

32. Elasticities of Demand and Supply32 PRICE ELASTICITY OF DEMAND  Total Revenue and Price Elasticity of Demand Unit elastic demand Total revenue does not change when price changes. When price increases, the percentage decrease in quantity demanded just equals the percentage increase in price. They are exactly offsetting. Therefore, total revenue is unchanged. When price decreases, the percentage increase in quantity demanded just equals the percentage decrease in price. They are exactly offsetting. Therefore, total revenue is unchanged.

33. Elasticities of Demand and Supply33 PRICE ELASTICITY OF DEMAND  Total Revenue and Price Elasticity of Demand Inelastic demand Total revenue changes in the same direction as price. When price increases, the percentage decrease in quantity demanded is smaller than the percentage increase in price. Therefore, total revenue increases. When price decreases, the percentage increase in quantity demanded is smaller than the percentage decrease in price. Therefore, total revenue decreases.

34. Elasticities of Demand and Supply34 PRICE ELASTICITY OF DEMAND  Total Revenue and Price Elasticity of Demand Determining elasticity from changes in price and total revenue If price and total revenue (or total expenditure) change in opposite directions, demand is elastic. If a price change leaves total revenue (or total expenditure) unchanged, demand is unit elastic. If price and total revenue (or total expenditure) change in the same direction, demand is inelastic.

35. Elasticities of Demand and Supply35 PRICE ELASTICITY OF DEMAND At $3 a cup, the quantity demanded is 15 cups an hour. Total revenue is $45 an hour. Total revenue decreases to $25 an hour. When the price rises to $5 a cup, the quantity demanded decreases to 5 cups an hour. Demand is elastic. Total Revenue and Elastic Demand

36. Elasticities of Demand and Supply36 PRICE ELASTICITY OF DEMAND At $50 a book, the quantity demanded is 5 million books. Total revenue is $250 million. Total revenue increases to $300 million. When the price rises to $75 a book, the quantity demanded decreases to 4 million books. Demand is inelastic. Total Revenue and Inelastic Demand

37. Elasticities of Demand and Supply37 Application: Elasticity and the Demand for Smoking

38. Elasticities of Demand and Supply38 ELASTICITY AND THE DEMAND FOR SMOKING Example: Oregon’s Anti- Smoking Campaign In November 1996, residents of Oregon approved a ballot measure increasing the excise tax on sellers of cigarettes by $0.30 per pack. The average price per pack increased from $1.75 to $2.05. Annual per capita consumption decreased from 92 packs to 86 packs.

39. Elasticities of Demand and Supply39 ELASTICITY AND THE DEMAND FOR SMOKING Example: Oregon’s Anti- Smoking Campaign 10% of the additional tax revenue was allocated to the Oregon Health Division (OHD) to develop and implement a tobacco-use prevention program. Because of the fall in demand, annual per capita consumption decreased by an additional 4 packs, from 86 to 82.

40. Elasticities of Demand and Supply40  Addiction and Elasticity Nonusers Nonusers’ demand for addictive substances is elastic. For example, the estimated elasticity of demand for cigarettes among teenage nonusers is 1.2. Therefore, a moderately higher price leads to a substantially smaller number of people trying a drug. ELASTICITY AND THE DEMAND FOR SMOKING

41. Elasticities of Demand and Supply41  Addiction and Elasticity Users Existing users’ demand for addictive substances is inelastic. For example, the estimated elasticity of demand for cigarettes among adult smokers is 0.4. Therefore, a substantial price rise brings only a modest decrease in the quantity demanded. Even addicted users, however, may reduce their consumption at the margin so demand is not perfectly inelastic. ELASTICITY AND THE DEMAND FOR SMOKING

42. Elasticities of Demand and Supply42 Price Elasticity of Supply

43. Elasticities of Demand and Supply43 PRICE ELASTICITY OF SUPPLY  Price Elasticity of Supply Definition The price elasticity of supply is the ratio of the percentage change in the quantity supplied to the percentage change in price. It is a measure of the extent to which the quantity supplied of a good changes when the price of the good changes.

44. Elasticities of Demand and Supply44 PRICE ELASTICITY OF SUPPLY Calculating Supply Elasticity: Example The price elasticity of supply equals 120% divided by 66.67%, or 1.8. The quantity increase is 120% of the average quantity. If the price of a bunch of roses increases from $40 to $80, the quantity supplied increases from 6 to 24 million bunches per month. The price increase is 66.67% of the average price.

45. Elasticities of Demand and Supply45 PRICE ELASTICITY OF SUPPLY  Elastic and Inelastic Supply Supply is elastic if the percentage change in quantity supplied is greater than the percentage change in price the coefficient of the elasticity of supply is greater than 1.

46. Elasticities of Demand and Supply46 PRICE ELASTICITY OF SUPPLY A 10% rise in the price of a book,... increases the quantity supplied by 20%. The increase in quantity supplied is greater than the increase in price. Therefore, the supply of books is elastic. Elastic Supply

47. Elasticities of Demand and Supply47 PRICE ELASTICITY OF SUPPLY  Elastic and Inelastic Supply Supply is unit elastic if the percentage change in quantity supplied is the same as the percentage change in price the coefficient of the elasticity of supply equals 1.

48. Elasticities of Demand and Supply48 PRICE ELASTICITY OF SUPPLY A 10 % rise in the price of fish,... increases the quantity supplied of fish by 10%. The increase in quantity supplied is the same as the increase in price. Therefore, the supply of fish is unit elastic. Unit Elastic Supply

49. Elasticities of Demand and Supply49 PRICE ELASTICITY OF SUPPLY  Elastic and Inelastic Supply Supply is inelastic if the percentage change in quantity supplied is smaller than the percentage change in price the coefficient of the elasticity of supply is less than 1.

50. Elasticities of Demand and Supply50 PRICE ELASTICITY OF SUPPLY A 20% rise in the price of a hotel room,... increases the quantity supplied of hotel rooms by 10%. The increase in quantity supplied is smaller than the increase in price. Therefore, the supply of hotel rooms is inelastic. Inelastic Supply

51. Elasticities of Demand and Supply51 PRICE ELASTICITY OF SUPPLY  Elastic and Inelastic Supply Supply is perfectly elastic if the quantity supplied changes by a very large percentage in response to an almost zero percentage change in price. the coefficient of the elasticity of supply is infinite (the numerator is very large and the denominator is infinitesimally small).

52. Elasticities of Demand and Supply52 PRICE ELASTICITY OF SUPPLY Even a very small rise in the the price,... increases the quantity supplied by a very large amount. The change in the quantity supplied is much (infinitely) larger than the change in price. Supply is perfectly elastic. Special Case: Perfectly Elastic Supply

53. Elasticities of Demand and Supply53 PRICE ELASTICITY OF SUPPLY  Elastic and Inelastic Supply Supply is perfectly inelastic if the percentage change in quantity supplied is zero when the price changes. the coefficient of the elasticity of supply equals 0.

54. Elasticities of Demand and Supply54 PRICE ELASTICITY OF SUPPLY A small rise in the price of a beachfront lot,... increases the quantity supplied by 0%. There is no change in quantity supplied when price changes. Therefore, the supply of beachfront lots is perfectly inelastic. Special Case: Perfectly Inelastic Supply

55. Elasticities of Demand and Supply55 PRICE ELASTICITY OF SUPPLY  Variables That Influence the Price Elasticity of Supply Influences on the price elasticity of supply include Substitution possibilities Time

56. Elasticities of Demand and Supply56 PRICE ELASTICITY OF SUPPLY  Variables That Influence the Price Elasticity of Supply Substitution possibilities If producers have good substitution possibilities for their resources, then the good can be produced at a constant or very gently rising opportunity cost, and t he supply of the good is relatively elastic. If the resource substitution possibilities are not good, then the opportunity cost of producing the good increases rapidly, and the supply of the good is relatively inelastic. At the extreme, if there are no resource substitution possibilities, the good can be produced only in a fixed quantity, and the supply of the good is perfectly inelastic.

57. Elasticities of Demand and Supply57 PRICE ELASTICITY OF SUPPLY  Variables That Influence the Price Elasticity of Supply Substitution possibilities and storage Storage provides producers with a way of substituting future sales for current sales. The lower the cost of storing a good, ceteris paribus, the more elastic is its supply. On the other hand, the supply of a non-storable good is highly inelastic.

58. Elasticities of Demand and Supply58 PRICE ELASTICITY OF SUPPLY  Variables That Influence the Price Elasticity of Supply Time As time passes after a price change, producers find it easier to change their production plans. Therefore, the longer the time elapsed since the price change, ceteris paribus, the more elastic is the supply of the good.

59. Elasticities of Demand and Supply59 Cross Elasticity and Income Elasticity

60. Elasticities of Demand and Supply60 CROSS ELASTICITY AND INCOME ELASTICITY  Cross Elasticity of Demand Definition The ratio of the percentage change in quantity demanded of a good to the percentage change in the price of another good that is a substitute or a complement. It is a measure of the extent to which the demand for a good changes when the price of a substitute or complement changes, other things remaining the same.

61. Elasticities of Demand and Supply61 CROSS ELASTICITY AND INCOME ELASTICITY  Cross Elasticity of Demand

62. Elasticities of Demand and Supply62 CROSS ELASTICITY AND INCOME ELASTICITY  Cross Elasticity of Demand Example 1 Suppose that when the price of a burger falls by 10 percent, the quantity of pizza demanded decreases by 5 percent.

63. Elasticities of Demand and Supply63  Cross Elasticity of Demand Substitutes The cross elasticity of demand for a substitute is positive. A fall in the price of a substitute brings a decrease in the quantity demanded of the good. The quantity demanded of a good and the price of its substitute change in the same direction. CROSS ELASTICITY AND INCOME ELASTICITY

64. Elasticities of Demand and Supply64 CROSS ELASTICITY AND INCOME ELASTICITY  Cross Elasticity of Demand Example 2 Suppose that when the price of a soda falls by 10 percent, the quantity of pizza demanded increases by 2 percent. Cross elasticity of demand for pizza 2 percent – 10 percent ==-0.2

65. Elasticities of Demand and Supply65  Cross Elasticity of Demand Complements The cross elasticity of demand for a complement is negative. A fall in the price of a complement brings an increase in the quantity demanded of the good. The quantity demanded of a good and the price of its complement change in opposite directions. CROSS ELASTICITY AND INCOME ELASTICITY

66. Elasticities of Demand and Supply66 Pizzas and burgers are substitutes. Cross elasticity is positive. Pizzas and soda are complements. Cross elasticity is negative. CROSS ELASTICITY AND INCOME ELASTICITY Cross Elasticity of Demand

67. Elasticities of Demand and Supply67  Income Elasticity of Demand Definition The ratio of the percentage change in quantity demanded to the percentage change in income. It is a measure of the extent to which the demand for a good changes when income changes, other things remaining the same. CROSS ELASTICITY AND INCOME ELASTICITY

68. Elasticities of Demand and Supply68  Income Elasticity of Demand CROSS ELASTICITY AND INCOME ELASTICITY The income elasticity is greater than 1 for a normal good in elastic demand. between 1 and 0 for a normal good in inelastic demand. between 0 and -1 for an inferior good in inelastic demand. smaller than -1 for an inferior good in elastic demand.

69. Elasticities of Demand and Supply69 Application: Tax Incidence

70. Elasticities of Demand and Supply70 APPLICATION: TAX INCIDENCE  Tax Incidence Definition The division of the burden of a tax between the buyer and the seller. If the price rises by the full amount of the tax, then the burden of the tax falls entirely on the buyer. If the price doesn’t change, then the burden of the tax falls entirely on the seller. If the price rises by a lesser amount than the tax, then the burden of the tax falls partly on the buyer and partly on the seller.

71. Elasticities of Demand and Supply71 APPLICATION: TAX INCIDENCE  Tax Incidence Legal incidence and economic incidence The tax legislation defines the legal incidence of a tax. The legal incidence specifies the individuals who are legally liable for payment of the tax to the government, who bear the initial burden of the tax. If the individuals who bear the legal incidence can shift the burden of the tax to others, the economic incidence is different from the legal incidence. The economic incidence is determined by the elasticities of demand and supply. It is independent of the legal incidence.

72. Elasticities of Demand and Supply72 APPLICATION: TAX INCIDENCE A $10 tax per CD player imposed on sellers of CD players shifts the supply curve to S + tax. Economic Incidence of a Tax on CD Players (1) With no tax, the price of a CD player is $100 and 5,000 CD players a week are bought.

73. Elasticities of Demand and Supply73 APPLICATION: TAX INCIDENCE Sellers receive $95 after payment of the tax—a decrease of $5 per CD player. Economic Incidence of a Tax on CD Players (2) The equilibrium price rises to $105—an increase of $5 a CD player. The equilibrium quantity decreases to 2,000 CD players a week.

74. Elasticities of Demand and Supply74 APPLICATION: TAX INCIDENCE The burden of the tax is split equally between the buyer and the seller—each pays $5 per CD player. Economic Incidence of a Tax on CD Players (3) The government collects tax revenue of $20,000 a week—the purple rectangle.

75. Elasticities of Demand and Supply75  Tax Incidence and Price Elasticities of Demand and Supply Economic incidence depends on elasticities of demand and supply The economic incidence of a tax is not always equally divided between buyers and sellers. In general, the distribution of the economic incidence between buyers and sellers depends on the price elasticities of demand and supply. APPLICATION: TAX INCIDENCE

76. Elasticities of Demand and Supply76 APPLICATION: TAX INCIDENCE Tax Incidence in a Market with Perfectly Elastic Supply—The Market for Sand A tax of 1¢ a pound increases the price by 1¢ a pound, and the buyer pays all the tax.

77. Elasticities of Demand and Supply77 APPLICATION: TAX INCIDENCE Tax Incidence in a Market with Perfectly Inelastic Demand—The Market for Insulin A tax of 20¢ a dose raises the price by 20¢, and the buyer pays all the tax.

78. Elasticities of Demand and Supply78 APPLICATION: TAX INCIDENCE Tax Incidence in a Market with Perfectly Elastic Demand—The Market for Pink Marker Pens A tax of 10¢ a pen lowers the price received by the seller by 10¢, and the seller pays all the tax.

79. Elasticities of Demand and Supply79 APPLICATION: TAX INCIDENCE Tax Incidence in a Market with Perfectly Inelastic Supply—The Market for Spring Water A tax of 5¢ a bottle lowers the price received by the seller by 5¢, and the seller pays all the tax.

80. Elasticities of Demand and Supply80  Tax Incidence and Price Elasticities of Demand and Supply Elasticities and tax incidence: summary Holding the elasticity of supply constant, the price rises more when the elasticity of demand is lower (more inelastic or less elastic). Therefore, the buyer pays a larger share of the tax the lower is the elasticity of demand for the good. Holding the elasticity of demand constant, the price rises less when the elasticity of supply is lower (more inelastic or less elastic). Therefore, the seller pays a larger share of the tax the lower is the elasticity of supply of the good. APPLICATION: TAX INCIDENCE

81. Elasticities of Demand and Supply81  Example: Incidence of the Payroll Tax Legal Incidence Social security and Medicare are financed by a payroll tax. The total tax is 15.3% of an employer’s payroll. The legal incidence of the payroll tax is divided equally between the employer and the employee. The employer pays 7.65% of each worker’s pay and the employee has 7.65% deducted from his or her pay. Who really pays the payroll tax? APPLICATION: TAX INCIDENCE

82. Elasticities of Demand and Supply82  Example: Incidence of the Payroll Tax Economic Incidence Empirical evidence shows that the supply of labor of primary workers (usually, but not always, male) is very inelastic. With a very inelastic supply, the economic incidence of a tax is mostly on the supplier. The workers or employees are the suppliers of labor. Therefore, no matter how the legal incidence is divided between employers and workers, the economic incidence of the tax is mostly on workers. The net wage received by workers is approximately 15.3% lower than it would be if there were no payroll tax. APPLICATION: TAX INCIDENCE

83. Elasticities of Demand and Supply83  Example: Incidence of Taxes on Business Legal Incidence Businesses do not pay taxes in any real economic sense. Only people pay taxes. All of a business’s revenues are derived from people (consumers) and ultimately become income to other people (employees, suppliers of other resources, owners and shareholders). Even though the legal incidence of a tax may be on business, the economic incidence must rest on people. APPLICATION: TAX INCIDENCE

84. Elasticities of Demand and Supply84  Example: Incidence of Taxes on Business Economic Incidence: What Are the Possibilities? Just because the legal incidence of a tax is on business income or profits does not necessarily mean that profits are lower by the amount of the tax. The tax may instead raise prices or reduce wages or lower the prices paid to other resource suppliers. APPLICATION: TAX INCIDENCE

85. Elasticities of Demand and Supply85  Example: Incidence of Taxes on Business Consumers If consumer demand for the goods produced by the business is relatively inelastic, then the economic incidence of a tax on business rests at least in part on consumers. They pay higher prices than they would if there were no tax and the tax on business is really a tax on consumers. APPLICATION: TAX INCIDENCE

86. Elasticities of Demand and Supply86  Example: Incidence of Taxes on Business Workers If workers’ supply of labor to the business is relatively inelastic, then the economic incidence of a tax on business rests at least in part on the business’s employees. They receive a lower net wage than they would if there were no tax, and the tax on business is really a tax on the incomes of workers. APPLICATION: TAX INCIDENCE

87. Elasticities of Demand and Supply87  Example: Incidence of Taxes on Business Suppliers of other resources If the supply of other factors of production (physical capital, land) is relatively inelastic, then the economic incidence of a tax on business rests at least in part on the owners of these other factors. They receive a lower price than they would if there were no tax, and the tax on business is really a tax on the incomes of suppliers of other factors. APPLICATION: TAX INCIDENCE

88. Elasticities of Demand and Supply88  Example: Incidence of Taxes on Business Investors, entrepreneurs and suppliers of financial capital If the supply of financial capital and entrepreneurship to the business is relatively inelastic, then the economic incidence of a tax on business rests at least in part on the business’s owners and shareholders. They receive a lower net return on their investment than they would if there were no tax. Only in this case is a tax on business truly a tax on the profits of owners and shareholders. APPLICATION: TAX INCIDENCE

89. Elasticities of Demand and Supply89  Example: Incidence of Taxes on Business Who ultimately bears the economic incidence of a tax on business? Legislators have no influence over the economic incidence of taxes on business. Economics, not politics, determines where the ultimate burden of taxes on business rests. Because the supply of labor is very inelastic and consumer demand is often less elastic than the supply of capital or entrepreneurship, a large part of any broad-based tax on business is likely to rest on workers and consumers, not on owners and shareholders. Taxes on business are more likely to be paid by consumers or workers than by owners and investors. APPLICATION: TAX INCIDENCE