2. Economics 111.3 Winter 14 February 5 th, 2014 Lecture 11 Ch. 4 Ch. 6 (up to p. 138)

5. Food

6. INCOME ELASTICITIES OF DEMAND: A relationship is described as When its magnitude is Which means that Income elastic (normal good) Greater than 1 The percent increase in the quantity demanded is greater than the percentage increase in income. Income inelastic (normal good) Less than 1 but greater than zero The percent increase in the quantity demanded is less than the percentage increase in income. Negative income elastic (inferior good) Less than zero When income increases, quantity demanded decreases.

7. Study question The demand for voice mail is Q = 1,000- 150P + 25I. Assume that per capita income I is $900. At a price P of $50, calculate the income elasticity of demand.

9. Es=Es=Es=Es= Percentage change in quantity supplied of product X Percentage change in the price of product X Price Elasticity of Supply

10. Perfectly Inelastic Supply Price Quantity S1S1S1S1 Elasticity of supply = 0 0 Quantity supplied is the same for any price!

11. Perfectly Elastic Supply Price Quantity S3S3S3S3 Elasticity of supply = 0 Suppliers will offer ANY quantity at this price

12. Unit Elastic Supply Price Quantity S1S1S1S1 0 S2S2S2S2 Elasticity of supply = 1

13. The main determinant of E s is the amount of time producers have for responding to a change in product price

14. 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.

15. 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

16. The Mechanism of Tax Incidence Tax of $2 per unit S shifts up $2 S D StStStSt tax

17. The Mechanism of Tax Incidence Equilibrium price rises to $9 How the burden of the tax is divided?$9S D StStStSt tax

18. The Mechanism of Tax Incidence Equilibrium price rises to $9 Consumer’s burden is the amount of the price increase = $1 S D StStStSt ta x $9

19. The Mechanism of Tax Incidence 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 S D StStStSt ta x $9

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21. If Supplier is required to pay a tax, the new equilibrium can be found at: P(Q D ) = P(Q S ) + Tax If Demander is required to pay a tax, the new equilibrium can be found at P(Q D ) - Tax = P(Q S )

24. Conclusion The incidence of a tax does not depend on whether the tax is levied on buyers or sellers.

25. STUDY QUESTION:

27. 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. Important question

28. Sales Tax and the Elasticity of Supply Quantity Price 45 50 100 S D Perfectly inelastic supply Seller pays entire tax

29. Sales Tax and the Elasticity of Supply Quantity (thousands of kilograms per week) Price (cents per pound) 10 11 3 5 3 5 S D S + tax Buyer pays entire tax Perfectly Elastic Supply

30. Sales Tax and the Elasticity of Demand Quantity (thousands of marker pens per week) 1 4 1 4 0.90 1.00 S S + tax Sellerpaysentiretax Price (cents per pen) Perfectly elastic demand

31. Sales Tax and the Elasticity of Demand Quantity (thousands of doses per day) Price (dollars per dose) 2.00 2.20 100 D S Perfectly inelastic demand S + tax Buyer pays entire tax

32. Tax Division and Price Elasticity of Demand Four extremes: Perfectly inelastic supply: seller pays Perfectly inelastic supply: seller pays Perfectly elastic supply: buyer pays Perfectly elastic supply: buyer pays Perfectly inelastic demand: buyer pays Perfectly inelastic demand: buyer pays Perfectly elastic demand: seller pays Perfectly elastic demand: seller pays

35. 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.

36. 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.