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Transcript of 1 Determinants of Elasticity 1.Availability of substitutes 2.Necessities vs. Luxuries 3.Importance...
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Determinants of Elasticity
1. Availability of substitutes2. Necessities vs. Luxuries3. Importance in the Buyer’s Budget4. 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
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Two Practical Examples
1. Elasticity and Mass Transit• long-run demand for mass transit is
inelastic• An increase in fares
– would increase revenue– would decrease ridership
2. Elasticity and an Oil Crisis• to bring about 1% percent decrease in
world oil demand• oil prices would have to rise by 6.67%
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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
Income
QE DY
%
%
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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
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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)
y
Dxy P
QE x
%
%
• Substitutes: Exy >0
• Complements: Exy <0
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Price Elasticity of Supply
• Percentage change in quantity of a good supplied, caused by a 1% change in the price of the good
P
QE SS
%
%
• The more easily suppliers can switch from/to alternate goods, the more elastic the supply
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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
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An Excise Tax on Sellers - Airlines• Figure 7 A Tax on Sellers Shifts the Supply Curve Upward
S1
SAfter Tax
$360
300
10
Price per
Ticket
Millions of
Tickets per Year
A
A’
with a $60 tax, the
airlines must get $60 more
than before to supply any
given number of tickets.
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An Excise Tax on Sellers - Airlines• Figure 8 The Effect of an Excise Tax Imposed on Sellers
S1
Safter tax$360
300
10
Price per
Ticket
Millions of
Tickets per Year
A
B
Before the tax
After the tax
Buyers pay $40 of the tax
Sellers pay $20 of the tax
340
D
7.5
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An Excise Tax on Buyers• Figure 9 A Tax on Buyers Shifts the Demand Curve Downward
$300
240
10
Price per
Ticket
Millions of
Tickets per Year
A’
A
D1
D After Tax
with a $60 tax imposed on buyers
they must be charged $60 less
than before to demand any
given number of tickets.
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An Excise Tax on Buyers• Figure 10 The Effect of an Excise Tax Imposed on Buyers
300
10
Price per
Ticket
Millions of
Tickets per Year
A
D1
D After Tax
Before the tax
S
C280
$340
7.5
After the tax
Buyers pay $40 of the tax
Sellers pay $20 of the tax
280
$340
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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)
12
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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
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The War on Drugs
P1
Q1
D1
A
S1
Quantity
Price per Unit
• Figure 11a The War on Drugs
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The War on Drugs
B
Q1
S2
P2
Q2
P1
D1
S1
Quantity
Price per Unit
A
• Figure 11b The War on Drugs
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The War on Drugs
P1
Q1
D1
A
S1
Quantity
Price per Unit
C
D2
Q3
P3
• Figure 11c The War on Drugs