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Economics 111.3 Winter 14
February 5th, 2014
Lecture 11
Ch. 4
Ch. 6 (up to p. 138)
Food
INCOME ELASTICITIES OF DEMAND:
A relationship is
described as
Income elastic
(normal good)
Income inelastic
(normal good)
Negative income
elastic
(inferior good)
When its
magnitude is
Which means that
Greater than 1
The percent increase in the
quantity demanded is greater
than the percentage increase
in income.
Less than 1 but greater
than zero
The percent increase in the
quantity demanded is less
than the percentage increase
in income.
Less than zero
When income increases,
quantity demanded
decreases.
Study question
• The demand for voice mail is Q = 1,000150P + 25I. Assume that per capita
income I is $900. At a price P of $50,
calculate the income elasticity of
demand.
Price Elasticity of Supply
Es=
Percentage change in quantity
supplied of product X
Percentage change in
the price of product X
Price
Perfectly Inelastic Supply
S1
Elasticity of
supply = 0
Quantity supplied is
the same for any
price!
0
Quantity
Perfectly Elastic Supply
Elasticity of
supply =
Price

S3
Suppliers will offer
ANY quantity at
this
price
0
Quantity
Price
Unit Elastic Supply
S1
Elasticity of
supply = 1
S2
0
Quantity
The main determinant of Es is the amount of
time producers have for responding to a
change in product price
ELASTICITIES OF SUPPLY:
A relationship is
described as
When its
magnitude is
Which means that
Perfectly elastic
Infinity
The smallest possible increase in
price causes an infinitely large
increase in the quantity supplied.
Elastic
Less than infinity
but greater than 1
The percent increase in the
quantity supplied exceeds the
percentage increase in the price.
Inelastic
Greater than zero
but less than 1
The percentage increase in the
quantity supplied is less than the
percentage increase in price.
Perfectly inelastic
Zero
The quantity supplied is the
same at all prices.
TAX Incidence
• Tax incidence is the manner in
which the burden of a tax is
shared among participants in a
market.
• Quantity Tax is a tax levied per
unit of quantity bought or sold
The Mechanism of Tax Incidence
Figure 5-4
St
14
12
tax
price
10
S
8
6
D
4
2
0
0
5
10
15
quantity
20
25
• Tax of $2 per unit
• S shifts up $2
The Mechanism of Tax Incidence
Figure 5-4
St
14
12
tax
price
10
S
$9
8
6
D
4
2
0
0
5
10
15
quantity
20
25
• Equilibrium price
rises to $9
• How the burden
of the tax is
divided?
The Mechanism of Tax Incidence
Figure 5-4
• Equilibrium price rises to
$9
St
• Consumer’s burden is
ta
the amount of the price
x S
increase = $1
14
12
price
10
$9
8
6
D
4
2
0
0
5
10
15
quantity
20
25
The Mechanism of Tax Incidence
Figure 5-4
St
14
ta
x
12
price
10
$9
S
8
6
D
4
2
0
0
5
10
15
quantity
20
25
• Equilibrium price
rises to $9
• Consumer’s
burden is the
amount of the
price increase = $1
• Firm’s burden =
tax-consumer’s
burden =$2 - $1 =
$1
Copyright © 2013 Pearson Canada Inc., Toronto, Ontario
• If Supplier is required to pay a tax, the
new equilibrium can be found at:
P(QD) = P(QS) + Tax
• If Demander is required to pay a tax, the
new equilibrium can be found at
P(QD) - Tax = P(QS)
Conclusion
• The incidence of a tax does not
depend on whether the tax is
levied on buyers or sellers.
STUDY QUESTION:
Important question
• In what proportions is the burden of the
tax divided?
• How do the effects of taxes on sellers
compare to those levied on buyers?
• The answers to these questions depend
on the elasticity of demand and the
elasticity of supply.
Sales Tax and the
Elasticity of Supply
S
Price
50
Seller pays
entire tax
Perfectly
inelastic
supply
45
D
100
Quantity
Price (cents per pound)
Sales Tax and the
Elasticity of Supply
Perfectly Elastic
Supply
S + tax
11
10
Buyer
pays
entire
tax
S
D
3
5
Quantity (thousands of
kilograms per week)
Price (cents per pen)
Sales Tax and the
Elasticity of Demand
S + tax
S
1.00
Seller
pays
entire
tax
Perfectly elastic
demand
0.90
1
4
Quantity (thousands of marker pens per week)
Price (dollars per dose)
Sales Tax and the
Elasticity of Demand
S + tax
Buyer pays
entire tax
S
2.20
Perfectly inelastic
demand
2.00
D
100
Quantity
(thousands of doses per day)
Tax Division and Price Elasticity
of Demand
Four extremes:
• Perfectly inelastic supply: seller pays
• Perfectly elastic supply: buyer pays
• Perfectly inelastic demand: buyer pays
• Perfectly elastic demand: seller pays
The Rule of Tax Incidence:
Generalization
The burden tends to fall on the side of the market that
is less elastic: The more elastic the supply, the larger
is the amount of tax paid by the buyer and vice versa
Sales tax is generally applied to items with a low
elasticity of demand (alcohol, tobacco, and
gasoline): Quantity does not decrease by much;
large tax revenue
It is unusual to apply sales tax to goods with a high
elasticity of demand.
Study question
The supply of and demand for roses are given by
P = 4Qs and P = 12 –2Qd respectively.
Answer the following questions:
A. Suppose the government decides to tax the suppliers of
roses $6 per dozen roses sold. How much tax does
Government collect and who pays it?
B. Calculate the deadweight loss associated with this $6
tax.