Elasticities, Taxes & Subsidies Flashcards
What is price elasticity of demand (PED) and the formula?
The responsiveness of demand of a product when there is a change in price.
PED = % change in demand / % change in price
What are 4 factors affecting PED?
Availability/ no. of substitutes, proportion of income, necessity/ addictive, time.
Why may PED be inelastic? [0 < PED < 1] (Steep curve)
No alternatives, bought infrequently, low % of income, no time.
Why may PED be elastic? [PED > 1} (Flatter curve)
Not necessity or addictive, expensive/ big % of income, lots of substitutes, bought frequently
What is price elasticity of supply (PES) and the formula?
The responsiveness of supply of a product when there is a change in price.
PES = % change in supply / % change in price
What are 4 factors affecting PES?
Lots of time, spare capacity (available FoPs), mobility factors (adjusting production & resources), availability of stock.
What is income elasticity of demand?
The responsiveness of demand of a product when there is a change in income.
YED = % change in demand / % change in income
What is an inferior good and what are their YED?
As incomes rise, demand of a good falls. People have more money to buy goods they can now afford.
YED < 0, negative
What are normal goods and what are their YED?
As incomes rise, demand of a good rises. People have more money to buy more goods.
YED > 0, positive
What are luxury/ superior goods and what are their YED?
As incomes rise, demand of a good rises A LOT. People can now afford expensive goods.
YED > 1, positive & elastic
What are necessities and what are their YED?
As incomes rise, demand of a good rises a little, generally everyday items.
0 < YED < 1, positive & inelastic
When may a good be perfectly income inelastic (YED = 0)
When income has no effect on quantity demanded. Eg. water/ electricity bills.
What is cross-price elasticity of demand (XPED) and what is the formula?
The responsiveness of demand of one good when another good changes in price.
XPED = % change in demand of good x / % change in price of good y
What are substitute goods and what are their XPED?
Goods which are used for the same thing, you either get one or the other. (eg. wine and champagne)
XPED < 0
Close substitute - big negative
Weak substitute - small negative
What are complementary goods and what are their XPED?
Goods which are commonly used together. (eg. milk and cereal)
XPED > 0
Close complement - big positive
Weak complement - small positive
What is a direct tax?
Taxes imposed on income, wealth or a firm’s profits. (eg. income tax, corporation tax)
What is an indirect tax?
Taxes imposed on expenditure.
Specific and ad valorem taxes are types of indirect tax, what is the difference?
Specific tax - fixed amount of tax added to the market price of a G/S. (eg. excise duties on alcohol)
Ad valorem tax - amount of tax depends on the value of a good. Often depends on % of its value. (eg. VAT)
How do you show a specific tax on a D/S diagram?
A parallel shift to the left of the supply curve equal to the tax per unit.
How do you show an ad valorem tax on a D/S diagram?
A non parallel shift to the left of the supply curve.
As tax per unit is a % of its value, the two supply curves diverge as quantity increases.
What is consumer incidence and where is it shown on the diagram?
The consumer’s contribution to the tax.
Lower section of rectangle.
What is producer incidence and where is it shown on the diagram?
The producer’s contribution to the tax.
Upper section of rectangle.
What is deadweight loss and where is it shown on the diagram?
The overall economic loss due to the tax, causing a fall in demand.
Triangle between old and new quantity demanded.
How do you find total tax revenue?
Consumer + Producer incidence
Tax per unit x new quantity (specific only)
