CHAPTER 5 (2014)Apunte Inglés
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ECONOMICS. CHAPTER 5
ELASTICITY AND TAXATION
DEFINING AND MEASURING ELASTICITY.
Price elasticity of demand is the ratio of the percent change in the quantity demanded to the percent change in the price as we move along the demand curve.
! ! *Drop the minus sign - Price elasticity of demand is always negative because of the inverse relationship between price and quantity demanded- so drop the minus sign and use Absolute Value.
THE PRICE ELASTICITY OF DEMAND.
To calculate the price elasticity of demand we first calculate the percent change of the quantity demanded and the corresponding percent change in the price as we move along the demand curve.
The law in demand says that price and quantity demanded always move in opposite directions.
! -Positive percent change in price (rise in price) = Negative percent change in the quantity demanded.
! -Negative percent change in price (fall in price) = Positive percent change in quantity demanded.
*Price elasticity of demand is a negative number (in strictly mathematical terms).
THE MIDPOINT METHOD.
Price elasticity of demand compares the percent change in the quantity demanded with the percent change in price.
M I D P O I N T M E T H O D : Te c h n i q u e f o r calculating the percent change. In this approach, we calculate changes in a variable compared with the average, or midpoint, of the starting and final values.
ECONOMICS. CHAPTER 5 INTERPRETING THE PRICE ELASTICITY OF DEMAND.
Demand is perfectly inelastic = Quantity demanded doesn’t respond at all to changes in the price.
! *The demand curve is a vertical line.
Demand is perfectly elastic = Any price increase will cause the quantity demanded to drop to zero.
! *The demand curve is an horizontal line.
When the price elasticity of demand is greater than 1, economists say that demand is elastic.
! Price elasticity of demand > 1 When the price elasticity of demand is less than 1, they say that de- mand is inelastic.
! Price elasticity of demand < 1 The borderline case is unit-elastic demand, where the price elasticity of demand is—surprise—exactly 1.
! Price elasticity of demand = 1 ECONOMICS. CHAPTER 5 It’s important to know how demand is because this predicts how changes in the price of a good will affect the total revenue earned by producers from the sale of that good.
TOTAL REVENUE: Total value of sales of a good or service. It is equal to the price multiplied by the quantity sold.
! TOTAL REVENUE = PRICE X QUANTITY SOLD.
ELASTICITY AND TOTAL REVENUE.
When a seller raises the price of a good, there are TWO EFFECTS: ! ! ! 1-PRICE EFFECT: After a price increase, each unit sold sells at a higher price, which tends to raise revenue.
2-QUANTITY EFFECT: After a price increase, fewer units are sold, which tends to lower revenue.
-If demand of a good is ELASTIC = Increase in price reduces total revenue.
-If demand of a good is INELASTIC = Increase in price increases total revenue.
-If demand of a good is UNI-ELASTIC = Increase in price doesn’t change total revenue.
Price Elasticity of Demand is determined by: ! 1-Whether Close Substitutes Are Available ! 2-Whether the Good Is a Necessity or a Luxury ! 3-Share of Income Spent on the Good ! 4-Time OTHER DEMAND ELASTICITIES.
Measures the effect of the change in one good’s price on the quantity demanded of the other good.
! *Goods are SUBSTITUTES when the cross-price elasticity is POSITIVE.
! *Goods are COMPLEMENTS when the cross-price elasticity is NEGATIVE.
INCOME ELASTICITY OF DEMAND.
Percent change in the quantity of a good demanded when a consumer’s income changes divided by the percent change in the consumer’s income.
ECONOMICS. CHAPTER 5 ! *When the income elasticity is POSITIVE = NORMAL GOOD.
! ! ! -Quantity demanded at any given price increases as income increases.
*When the income elasticity is NEGATIVE = INFERIOR GOOD.! ! ! -Quantity demanded at any given price decreases as income increases.
PRICE ELASTICITY OF SUPPLY.
Is a measure of the responsiveness of the quantity of a good supplied to the price of that good.
! *It is the ratio of the percent change in the quantity supplied to the percent change in the price as we move ! along the supply curve.
! -Supply is perfectly inelastic: Price elasticity of supply is 0.
! ! *When changes in the price have no effect on the quantity supplied.
! ! Supply curve is a VERTICAL line.
! -Supply is perfectly elastic: Price elasticity of supply is infinite.
! ! *Any price change will lead to changes in the quantity supplied.
! ! Supply curve is an HORIZONTAL line.
WHAT FACTORS DETERMINE THE PES? ! 1-Availability of Inputs: The price elasticity of supply tends to be large when inputs are readily available ! and can be shifted into and out of production at a relatively low cost. It tends to be small when inputs are ! difficult to obtain.
! 2-Time: The price elasticity of supply tends to grow larger as producers have more time to respond to a ! price change. This means that the long-run price elasticity of supply is often higher than the short-run ! elasticity.
ECONOMICS. CHAPTER 5 ELASTICITY MENAGERIE.
ECONOMICS. CHAPTER 5 TAXATION.
EXCISE TAX: Tax on sales of a good or service.
! -When price elasticity of demand is higher than price elasticity of supply = Excise tax on the producers.
! -When price elasticity of supply is higher than price elasticity of demand = Excise tax on the consumers.
! *ELASTICITY determines the incidence of an excise tax.
THE REVENUE OF AN EXCISE TAX.
The general principle is: The revenue collected by an excise tax is equal to the are of the rectangle (A= Height x Width) whose height is the tax wedge between the supply and demand curves and whose width is the quantity transacted under the tax.
Ex: Excise tax is 40$ per room, and we have 5.000 rooms -- Revenue tax = 40 x 5000 = 200.000$.
TAX RATES AND REVENUE.
TAX RATE - Amount of tax people is required to pay per unit of whatever is being taxed.
! *Doubling the excise tax rate on a good or service won’t double the amount of revenue collected, because ! the tax increase will reduce the quantity of the good or service transacted.! ! -If taxes are higher, it means people have to pay more for a good/service. That means that tax revenue is ! ! ! not going to be higher, because people is not going to buy that much quantity of g/s.
-In some cases, raising the tax may actually reduce the amount of revenue the government collects.
THE COSTS OF TAXATION.
-A fall in the price of the good = Gain in the consumer surplus.
-Rise in the price of the good = Loss in consumer surplus.
-Excise tax raises the price paid by consumers (increase of the price of a good) -- Leads to a loss in consumer surplus. -- If the price increases, the consumer surplus decreases because consumers are not willing to pay more for a good that it used to cost less.
-A fall in the price received by producers = Fall in producers surplus.
CONCLUSION: A TAX REDUCES CONSUMER AND PRODUCER SURPLUS.
THE DEADWEIGHT LOSS OF A TAX.
Consumers and producers are hurt by the tax, but governments gain revenue.
*Deadweight loss caused by the tax represents the total surplus lost to society because of the tax—that is, the amount of surplus that would have been generated by transactions that now do not take place because of the tax.
COST OF COLLECTING TAXES.
Administrative costs of a tax: Resources used by the government to collect the tax. This lost resources are the administrative costs of a tax.
ECONOMICS. CHAPTER 5 TOTAL INEFFICIENCY CAUSED BY A TAX = Deadweight loss + administrative costs.
General rule of economic policy: Tax system should be designed to minimize the total inefficiency it imposes on society.
DEADWEIGHT LOSS AND ELASTICITIES.
-When demand is PERFECTLY INELASTIC = Quantity demanded is unchanged by the imposition of the tax.
! *Tax imposes no deadweight loss.
-When supply is PERFECTLY INELASTIC = Quantity supplied is unchanged by the tax and there is no deadweight loss.
If the goal is to minimize the deadweight loss = Taxes should be imposed on goods that have the most inelastic response.