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    Econ101 Demand and Supply - Application of Elasticity (Compatibility Mode)

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    Nessa Nessa
    econ101 demand and supply -Application of elasticity [Compatibility Mode]

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    Econ101 Demand and Supply - Application of Elasticity (Compatibility Mode)

    Uploaded by

    Nessa Nessa
    6 views13 pages
    econ101 demand and supply -Application of elasticity [Compatibility Mode]

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    econ101 demand and supply -Application of elasticity [Compatibility Mode]

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    econ101 demand and supply -Application of elasticity [Compatibility Mode]

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    6 views13 pages

    Econ101 Demand and Supply - Application of Elasticity (Compatibility Mode)

    Uploaded by

    Nessa Nessa
    econ101 demand and supply -Application of elasticity [Compatibility Mode]

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 13

    APPLICATION OF

    ELASTICITY
    Tax incidence

    - refers to who bears the burden of a tax.


    - Ultimate bearer of the tax
    - A tax can be placed on buyers (a consumption
    tax), or on sellers (a production tax).
    Excise tax

    - Government charge taxes on goods deemed to be


    ‘socially bad’ to discourage the consumption and
    production of the good.

    - Because cause harm to society.

    Examples of socially bads:-


    - Alcoholic beverages
    - Cigarettes
    - Fuel (petrol and diesel)
    Elasticity and Tax Incidence

    • In what proportions is the burden of the tax


    divided?
    The distribution of the burden
    of an excise tax btwn
    consumers and producers
    depends on the relative
    elasticities of ss and dd
    for the product.
    An example: The effect of a petrol
    excise tax

    -What happens when a tax of $t per litre of


    petrol is introduced?
    Illustration
    Price Supply with
    Tax added
    Pe + t
    E2 Value
    Buyers pay - of tax (t) Supply
    Pc
    (a) E1
    Pe

    Sellers
    receive - Ps

    Demand

    0 Q2= Qd with Q1 = Qd before Litres of petrol


    tax tax applied
    • Imposition of tax shift ss curve to s`
    • At original equilibrium: E1
    - To supply Q1, producers must receive Pe and
    buyers must pay Pe+ t.
    - However, an increase in price due to imposition
    of tax cause a movement along demand curve.
    - Rational buyers will reduce quantity demanded
    and new equilibrium will be at E2
    - Two prices will be distinguished:-
    Pc – consumer price, Ps – producer price.
    • At E2, Pc > Pe and Ps < Pe.
    • Comparing E1 and E2:
    - Pc is higher, Ps is lower, although the change in price is
    less than the full extent of the excise tax.
    Difference: Pc-Pe ------------ consumer’s contribution to tax
    - Ps – Pe --------------- producer’s contribution to tax.
    - Although the tax burden is usually shared between
    buyers and sellers, there are some cases where only
    one side bares the burden
    Importance of elasticity on the incidence of a tax

    • The slopes of the demand and supply curves


    will impact greatly on whether or not the
    buyer or seller bears a greater burden of a tax
    • The slopes of the curves also affect the
    amount of tax revenue collected
    • Think again about the link between elasticity
    of demand/supply and why some items are
    taxed and others not.
    How the Burden of a Tax Is Divided

    (a) Elastic Supply, Inelastic Demand – alcohol, cigarettes

    Price
    1. When supply is more elastic
    than demand . . .
    Price buyers pay, Pc-
    almost rises to the Supply
    full extent of the tax

    Tax
    2. . . . the
    incidence of the
    Price without tax -Pe tax falls more
    heavily on
    Price sellers consumers . . .
    Receive- Ps

    3. . . . than
    Demand
    on producers.

    0 Quantity

    When demand is inelastic relative to supply, consumers


    bear most of the burden of excise tax
    Copyright © 2004 South-Western/Thomson Learning
    How the Burden of a Tax Is Divided

    (b) Inelastic Supply, Elastic Demand

    Price
    1. When demand is more elastic
    than supply . . .
    Price buyers pay, Pc Supply

    Price without tax, Pe 3. . . . than on


    consumers.
    Tax

    2. . . . the Demand
    Price sellers incidence of
    Receive-Ps the tax falls
    more heavily
    on producers . . .

    0 Quantity
    When supply is inelastic relative to demand, producers bear
    most of the burden
    Copyright © 2004 South-Western/Thomson Learning
    Importance of elasticity and incidence of a tax

    • Experiment on your own with different slopes


    for the demand and supply curves.
    • Think about the case of perfectly elastic or
    inelastic demand/supply curves.
    summary

    So, how is the burden of the tax divided?

    • The burden of a tax falls more


    heavily on the side of the
    market that is less elastic.

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