Types of Demand Elasticities and Factors That Shift the Demand Curve

1. 5 Elasticity and Its Application

2. Types of Demand Elasticities • Generally 3 categories we are concerned about • Price elasticity • Own-price: • How quantity demanded changes with the (own) price • Cross-price • How quantity demanded changes with another (cross) good’s price changes • Income • How quantity demanded changes with a change in your income • Want to be able to measure/estimate how much Qd when a factor that shifts Demand Curve Changes • Also Measure Supply Elasticity • how much Qs changes when a factor changes, e.g., input price -> min wage and labor costs

3. Cross-Price and IncomeFactors That Shift the Demand Curve

4. Own-Price (Demand) Elasiticity • Economist use the (own) price elasticity of demand to summarize how responsive quantity demanded is to price • Demand curves are not always linear; and responsiveness can change with price

5. The (own-price) Elasticity of Demand • Variety of demand curves: own-price (absolute value) • Demand is elastic • Elasticity > 1 => ΔQ/Q > ΔP/P raise price => ΔTot Rev < 0 • Demand is inelastic • Elasticity < 1 => ΔQ/Q < ΔP/P raise price => ΔTot Rev > 0 • Demand has unit elasticity • Elasticity = 1 => ΔQ/Q =ΔP/P => ΔTot Rev = 0

6. Own-Price (Demand) Elasiticity

7. The (own-price) Elasticity of Demand • Determinants of (own) price elasticity of demand • Availability of close substitutes • Goods with close substitutes • More elastic demand • Necessities vs. luxuries • Necessities – inelastic demand • Luxuries – elastic demand • Definition of the market • Narrowly defined markets – more elastic demand • Time horizon • More elastic over longer time horizons

8. The Elasticity of Demand • Cigarettes (US)[41] • -0.3 to -0.6 (General) • -0.6 to -0.7 (Youth) – proportion of income? • Soft drinks • -0.8 to -1.0 (general)[51] (broadly defined) • -3.8 (Coca-Cola)[52] (narrow) • -4.4 (Mountain Dew)[52] (narrow) • Car fuel[45] • -0.25 (Short run) (same car – reduce trips) • -0.64 (Long run) (new car?)

9. Taxes • How taxes on buyers affect market outcomes • Initial impact on the demand • Demand curve shifts left • Lower equilibrium price • Lower equilibrium quantity • The tax – reduces the size of the market

10. 7 Equilibrium with tax A tax on buyers Tax ($0.50) Price of Ice-Cream Cone A tax on buyers shifts the demand curve downward by the size of the tax ($0.50). Equilibrium without tax Price buyers pay Price without tax $3.30 2.80 3.00 Price sellers receive 100 90 D2 Supply, S1 0 Quantity of Ice-Cream Cones When a tax of $0.50 is levied on buyers, the demand curve shifts down by $0.50 from D1 to D2. The equilibrium quantity falls from 100 to 90 cones. The price that sellers receive falls from $3.00 to $2.80. The price that buyers pay (including the tax) rises from $3.00 to $3.30. Even though the tax is levied on buyers, buyers and sellers share the burden of the tax. D1

11. Impact of a payroll tax Wage Tax wedge Wage firms pay Wage without tax Wage workers receive Labor supply 0 Quantity of Labor A payroll tax places a wedge between the wage that workers receive and the wage that firms pay. Comparing wages with and without the tax, you can see that workers and firms share the tax burden. This division of the tax burden between workers and firms does not depend on whether the government levies the tax on workers, levies the tax on firms, Labor demand

12. 9 How the burden of a tax is divided (a) Price (a) Elastic Supply, Inelastic Demand 1. When supply is more elastic than demand . . . Tax 2. . . . The incidence of the tax falls more heavily on consumers . . . 3. . . . Than on producers. Price buyers pay Price without tax Price sellers receive 0 Quantity Supply In panel (a), the supply curve is elastic, and the demand curve is inelastic. In this case, the price received by sellers falls only slightly, while the price paid by buyers rises substantially. Thus, buyers bear most of the burden of the tax. Demand

13. 9 How the burden of a tax is divided (b) Price (b) Inelastic Supply, Elastic Demand 1. When demand is more elastic than supply . . . 3. Than on consumers Tax 2. . . . The incidence of the tax falls more heavily on producers. Price buyers pay Price without tax Price sellers receive Demand 0 Quantity Supply In panel (b), the supply curve is inelastic, and the demand curve is elastic. In this case, the price received by sellers falls substantially, while the price paid by buyers rises only slightly. Thus, sellers bear most of the burden of the tax.

14. Taxes • Tax burden - falls more heavily on the side of the market that is less elastic • Small elasticity of demand • Buyers do not have good alternatives to consuming this good • Small elasticity of supply • Sellers do not have good alternatives to producing this good

15. Table 4.2Factors That Shift the Supply Curve