Elasticity ( 2 )

Question 1

What curve does tax affect?

Answer 1

• Taxes shift the supply curve not the demand curve.

Question 2

How do taxes affect goods with inelastic demands?

Answer 2

If a firm sells a good with an inelastic demand, they are likely to put most of the tax
burden on the consumer, because they know a price increase will not cause demand
to fall significantly. An increase in tax will decrease supply from S1 to S2, which
increases price from P1 to P2, and therefore demand contracts from Q1 to Q2.

Question 3

How does tax affect elastic demand goods?

Answer 3

If a firm sells a good with an elastic demand, they are likely to take most of the tax
burden upon themselves. This is because they know if the price of the good
increases, demand is likely to fall, which will lower their overall revenue

Question 4

How can governments use this knowledge of taxes & PED?

Answer 4

• Raising government revenue can be achieved through taxation of inelastic goods
• Increasing taxes on elastic goods can be used to reduce demand for the good, demand would fall significantly due to an increase in price.

Question 5

What is the formula for total revenue?

Answer 5

Average price x Quantity Sold

Question 6

How does a raising of price affect elastic & inelastic goods?

Answer 6

Inelastic goods:
Raising the price will not result in a significant response from demand, it will be less responsive to changes in price, and therefore the quantity sold will not decrease significantly increasing total revenue.
Elastic Goods:
If a good has an elastic demand and the firm raises its price, quantity sold will fall, as there will be a greater responsiveness from quantity demanded to a price change, leading to significant reduction in quantity demanded, leading to a decrease in total revenue.

Question 7

How do price changes affect firm’s revenue for elastic demand?

Answer 7

• Reduction in price will increase the firm’s total revenue

* Increase in price will reduce the firm’s total revenue

Question 8

How do price changes affect firm’s revenue for inelastic goods?

Answer 8

• Reduction in price will reduce the firm’s total revenue

* An increase in price will increase the firm’s total revenue

Question 9

What is the income elasticity of demand?

Answer 9

Measures how much the demand for a good changes with a change in real income.

Question 10

What is the formula for YED?

Answer 10

Percentage change in quantity demanded of a good / Percentage change in real income

Question 11

What is elastic income?

Answer 11

YED > 1

Question 12

What is inelastic income?

Answer 12

YED < 1

Question 13

What is cross elasticity of demand?

Answer 13

Measure of how the quantity demanded of one good responds to a change in the price of another good

Question 14

What is the formula for XED?

Answer 14

% Change in quantity demanded of good A / % Change in price of good B

Question 15

What is the XED for substitutes?

Answer 15

Positive

Question 16

What is the XED for complements?

Answer 16

Negative

Question 17

What is the XED for unrelated goods?

Answer 17

0

Question 18

What is the income elasticity of demand for normal goods?

Answer 18

• Positive YED, as incomes rise, demand increases.

* The size of demand increase is dependent on the product’s elasticity.

Question 19

What is the YED for luxury/superior goods?

Answer 19

YED > 1

Question 20

What is the YED for inferior goods and why?

Answer 20

• As incomes rise, demand falls, a rise in come will lead to the inferior good being replaced with one considered to be of higher quality
• Negative YED

Question 21

How does a fall in price affect XED of substitutes?

Answer 21

• Substitutes have positive XEDs, a fall in the price of one substitute will reduce the demand of another.
• The closer the substitute the higher the positive XED

Question 22

How does an increase in price affect XED of complements?

Answer 22

Goods that are complements have negative XEDs.

• An increase in the price of a good will lead to a reduction in demand for its complmements