Determinants of Elasticity Availability of substitutes Necessities vs. Luxuries Importance in the Buyer’s Budget 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

Two Practical Examples Elasticity and Mass Transit long-run demand for mass transit is inelastic An increase in fares would increase revenue would decrease ridership Elasticity and an Oil Crisis to bring about 1% percent decrease in world oil demand oil prices would have to rise by 6.67%

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 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

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) Substitutes: Exy >0 Complements: Exy <0

Price Elasticity of Supply Percentage change in quantity of a good supplied, caused by a 1% change in the price of the good The more easily suppliers can switch from/to alternate goods, the more elastic the supply

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

An Excise Tax on Sellers - Airlines Figure 7 A Tax on Sellers Shifts the Supply Curve Upward SAfter Tax Price per Ticket S1 $360 A’ with a $60 tax, the airlines must get $60 more than before to supply any given number of tickets. 300 A 10 Millions of Tickets per Year

An Excise Tax on Sellers - Airlines Figure 8 The Effect of an Excise Tax Imposed on Sellers Price per Ticket After the tax Buyers pay $40 of the tax Sellers pay $20 of the tax Safter tax $360 340 B S1 300 A Before the tax D 7.5 10 Millions of Tickets per Year

An Excise Tax on Buyers Figure 9 A Tax on Buyers Shifts the Demand Curve Downward with a $60 tax imposed on buyers they must be charged $60 less than before to demand any given number of tickets. Price per Ticket A $300 A’ 240 D1 D After Tax 10 Millions of Tickets per Year

An Excise Tax on Buyers Figure 10 The Effect of an Excise Tax Imposed on Buyers Price per Ticket Buyers pay $40 of the tax Sellers pay $20 of the tax S $340 $340 A Before the tax 300 280 280 C After the tax D1 D After Tax 7.5 10 Millions of Tickets per Year

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)

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

The War on Drugs Figure 11a The War on Drugs Price per Unit S1 A P1 D1 Quantity Price per Unit S1 A P1 D1 Q1

The War on Drugs Figure 11b The War on Drugs Quantity Price per Unit

The War on Drugs Figure 11c The War on Drugs Quantity Price per Unit