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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.