Chapter 4 Elasticity and Taxation ©2010 Worth Publishers Slides created by Dr. Amy Scott

Chapter 4

Elasticity and Taxation

©2010 Worth Publishers

Slides created by Dr. Amy Scott

More Precious than a Flu Shot

The U.S. supply of the flu vaccine for the 2004–2005 flu season was suddenly cut in half

As news of it spread, there was a rush to get the shots.

Some pharmaceutical distributers detected a profit - making opportunity in the frenzy.

Consumers of the vaccine were relatively unresponsive to price;

that is, the large increase in the price of the vaccine left the quantity demanded by consumers relatively unchanged.

In this chapter we will show how the price elasticity of demand is calculated and why it is the best measure of how the quantity demanded responds to changes in price.

Chapter Objectives

1. What is elasticity?

A. Price elasticity of demand

B. Cross-price elasticity of demand

C. Income elasticity of demand

D. Price elasticity of supply

2. The effects of taxes on supply and demand3. What determines who bears the burden of a

tax4. The costs and benefits of taxes, and why taxes

impose a cost that is larger than the tax revenue they raise

Defining and Measuring ElasticityThe 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

% ∆ Q % ∆ PDrop 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

Demand for Vaccinations

When price rises to $21 per barrel, world demand falls to 9.9 million barrels per day (point B).

D

10.09.9

$21

20

Price of vaccination

0Quantity of vaccinations (millions)

B

A

Calculating the Price Elasticity of Demand

1)

2)

3)

The Midpoint Method

Percentage change can vary depending on which variables are used to measure. To alleviate this problem:The midpoint method is a technique for

calculating the percent change using averages of starting and final values (midpoints).

Midpoint Method

Using the Midpoint Method

The price of strawberries falls from $1.50 to $1.00 per carton and the quantity demanded goes from 100,000 to 200,000 cartons. Using the midpoint method, the price elasticity of demand is:

1. 1.7. 2. 0.6. 3. 67. 4. 40.

At the present level of consumption, 4,000 movie tickets, and at the current price, $5 per ticket, the price elasticity of demand for movie tickets is 1. Using the midpoint method, calculate the percentage by which the owners of movie theaters must reduce price in order to sell 5,000 tickets.

1. 16%2. 32%3. 18%4. 22%

The price elasticity of demand for ice-cream sandwiches is 1.2 at the current price of $0.50 per sandwich and the current consumption level of 100,000 sandwiches. Calculate the change in the quantity demanded when price rises by $0.05.

1. quantity demanded increases by 12,0002. quantity demanded decreases by 12,0003. quantity demanded increases by 15,0004. quantity demanded decreases by 15,000

Use Equations 5-1 and 5-2 to calculate percent changes, and Equation 5-3 to relate price elasticity of demand to the percent changes.

Estimating Elasticities

Assumption: It’s easy to estimate price elasticities of demand from real-world data

Fact: Changes in price aren’t the only thing affecting changes in the quantity demanded. Other factors include:

changes in incomechanges in populationchanges in the prices of other goods

To estimate price elasticities of demand, economists must use careful statistical analysis to separate the influence of these different factors, holding other things equal.

Some Estimated Price Elasticities of Demand

Good Price elasticity

Inelastic demand Eggs 0.1 Beef 0.4 Stationery 0.5 Gasoline 0.5

Elastic demand Housing 1.2 Restaurant meals 2.3 Airline travel 2.4 Foreign travel 4.1

Price elasticity of demand<1

Price elasticity of demand>1

Interpreting Price Elasticity of Demand

Extreme Cases of Price Elasticity of Demand:

Demand is perfectly inelastic when the quantity demanded does not respond at all to changes in the price demand curve is a vertical line.

Demand is perfectly elastic when any price increase will cause the quantity demanded to drop to zero. demand curve is a horizontal line.

Interpreting Price Elasticity of Demand(continued)

Demand is elastic if the price elasticity of demand is greater than 1

Price Elasticity of Demand > 1Demand is inelastic if the price elasticity of demand is less than 1

Price Elasticity of Demand < 1Demand is unit-elastic if the price elasticity of demand is exactly 1

Price Elasticity of Demand = 1

Two Extreme Cases of Price Elasticity of Demand

D1

… leaves the quantity demanded unchanged.

An increase in price…

10Quantity of shoelaces (billions of pairs per year)

Perfectly Inelastic Demand: Price Elasticity of Demand = 0

$3

$2

Price of shoelaces (per pair)

At any price above $5, quantity demanded is zero

At exactly $5, consumers will buy any quantity

At any price below $5, quantity demanded is infinite

D2

0

Price Elastic Demand: Price Elasticity of Demand = ∞

$5

Price of pink tennis balls (per dozen)

Quantity of tennis balls (dozens per year)

Two Extreme Cases of Price Elasticity of Demand

Unit-Elastic Demand, Inelastic Demand, and Elastic Demand

A 20% increase in the price . . .

D1

. . . generates a 20% decrease in the quantity of crossings demanded.

Unit-Elastic Demand: Price Elasticity of Demand = 1

900 1,1000

$1.10

0.90

Price of crossing

Quantity of crossings (per day)

A

B

Demand is unit-elastic if the price elasticity of demand is exactly 1

D2

. . . generates a 10% decrease in the quantity of crossings demanded.

Inelastic Demand: Price Elasticity of Demand = 0.5

950 1,0500

$1.10

0.90

Price of crossing



A

B

Demand is inelastic if the price elasticity of demand is less than 1


… generates a 40% decrease in the quantity of crossings demanded.

D3

Elastic Demand: Price Elasticity of Demand = 2

800 1,2000

$1.10

0.90


Price of crossing


B

A

Demand is elastic if the price elasticity of demand is greater than 1


Why Does It Matter Whether Demand is Unit-Elastic, Inelastic, or Elastic?

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.

The total revenue is defined as the total value of sales of a good or service, i.e.

Total Revenue = Price × Quantity Sold

Total Revenue by Area

DTotal revenue = price x quantity = $990

1,1000

$0.90

Price of crossing


Total Revenue = Price × Quantity Sold

Elasticity and Total Revenue

When a seller raises the price of a good, there are two effects in action (except in the rare case of a good with perfectly elastic or perfectly inelastic demand): A price effect: After a price increase,

each unit sold sells at a higher price, which tends to raise revenue.

A quantity effect: After a price increase, fewer units are sold, which tends to lower revenue.

Figure 5.4b Effect of a Price Increase on Total Revenue

Price effect of price increase: higher price for each unit sold

D

Quantity effect of price increase: fewer units sold

B

C

A

900 1,1000

$1.10

0.90


Price of crossing

Elasticity and Total Revenue

If demand for a good is elastic (the price elasticity of demand > 1), an increase in price reduces total revenue. The quantity effect is stronger than the price

effect. Price TR

If demand for a good is inelastic (the price elasticity of demand < 1), a higher price increases total revenue. The price effect is stronger than the quantity

effect. Price TR

If demand for a good is unit-elastic (the price elasticity of demand = 1), an increase in price does not change total revenue. The sales effect and price effect exactly offset each other.

Price Elasticity of Demand and Total Revenue

Demand Schedule and Total Revenue

D

Demand is elastic: a higher reduces total revenue

Elastic

Inelastic

Unit-elastic

Demand is inelastic: a higher price increase total revenue

00 1 2 3 4 5 6 7 1098

$252421

16

9

Quantity

Total revenue

0 1 2 3 4 5 6 7 1098

$10987654321

Quantity

Price

$012345678

910

$09

1621242524211690

109876543210

Total Revenue

Quantity demanded

Demand Schedule and Total Revenue for a Linear Demand Curve

Price

The price elasticity of demand changes along the demand curve

What Factors Determine the Price Elasticity of Demand?

Price Elasticity of Demand is determined by:

Whether Close Substitutes Are Available Whether the Good Is a Necessity or a Luxury

Share of Income Spent on the Good

Time

How Mad?

For years tuition has been rising faster than the overall cost of living, but does rising tuition keep people from going to college?

A 1988 study found that a 3% increase in tuition led to an approximately 2% fall in the number of students enrolled at four-year institutions, giving a price elasticity of demand of 0.67 (2%/3%) and 0.9 for two-year institutions.

Enrollment decision for students at two-year colleges was significantly more responsive to price than for students at four-year colleges. The result: students at two-year colleges are more likely to forgo getting a degree because of tuition costs than students at four year colleges.

A 1999 study confirmed this pattern.

Responding to your tuition bill

Total revenue decreases when price increases.

1. elastic demand2. inelastic demand3. unit-elastic demand

For each case that follows choose the condition that best characterizes demand: elastic demand, inelastic demand or unit-elastic demand

The additional revenue generated by an increase in quantity sold is exactly offset by revenue lost from the fall in price received per unit.



Total revenue falls when output increases.



Producers in an industry find they can increase their total revenues by working together to reduce industry output.



For each case that follows, would you expect demand to be elastic or inelastic?

Demand by a snake-bite victim for an antidote

Demand by students for green erasers

1. elastic2. inelastic

1. elastic2. inelastic

Cross-Price Elasticity The cross-price elasticity of demand between two goods measures the effect of the change in one good’s price on the quantity demanded of the other good.

Equal to the percent change in the quantity demanded of one good divided by the percent change in the other good’s price.

The Cross-Price Elasticity of Demand between Goods A and B

Cross-Price Elasticity

Goods are substitutes when the cross-price elasticity of demand is positive.

Goods are complements when the cross-price elasticity of demand is negative.

Income Elasticity of Demand

The income elasticity of demand is the 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.

Normal Goods and Inferior Goods

When the income elasticity of demand is positive, the good is a normal good that is, the quantity demanded at any

given price increases as income increases.

When the income elasticity of demand is negative, the good is an inferior good that is, the quantity demanded at any

given price decreases as income increases.

The income elasticity of demand for food is much less than 1—it is income inelastic. As consumers grow richer, other things equal, spending on food rises less than income as the U.S. economy has grown, the share of income it spends on food—and therefore the share of total U.S. income earned by farmers—has fallen.

Agriculture has been a technologically progressive sector for approximately 150 years in the U.S., with steadily increasing yields over time. Competition among farmers means that technological progress leads to lower food prices. Meanwhile, the demand for food is price-inelastic, so falling prices of agricultural goods, other things equal, reduce the total revenue of farmers progress in farming has been good for consumers but bad for farmers.

Where Have All the Farmers Gone?

Why do so few people now live and work on farms in the United States?

Food’s Bite in World Budgets

200 40 60 100%

Income (% of U.S. income per capital)

80

80%

60

40

20

Spending on food (% of income)

Sri Lanka

Mexico

Israel United States

Spending It

A classic result of their surveys is that the income elasticity of demand for ‘food eaten at home’ is considerably less than 1. As a family’s income rises, the share of income spent on food consumed at home falls, and vice a versa as family income falls.

In 1950, 19% of U.S. income was spent on food consumed at home compared with 7% now. Over the same time period, the share of U.S. income spent on food away from home has stayed constant at 5%.

An example of an inferior good is rental housing. As family income rises demand for rental housing decreases since higher income families are likely to own their homes.

The Bureau of Labor Statistics captures data on spending.

After Chelsea’s income increased from $12,000 to $18,000 a year, her purchases of CDs increased from 10 to 40 CDs a year. Calculate Chelsea’s income elasticity of demand for CDs using the midpoint method.

1. 32. .3333. 14. 7

Expensive restaurant meals are income-elastic goods for most people, including Sanjay. Suppose his income falls by 10% this year. What can you predict about the change in Sanjay’s consumption of expensive restaurant meals?

1. Sanjay’s consumption of expensive restaurant meals will fall by 10%.

2. Sanjay’s consumption of expensive restaurant meals will rise by 10%.

3. Sanjay’s consumption of expensive restaurant meals will fall by more than 10%.

4. Sanjay’s consumption of expensive restaurant meals will rise by more than 10%.

As the price of margarine rises by 20%, a manufacturer of baked goods increases its quantity of butter demanded by 5%. Calculate the cross-price elasticity of demand between butter and margarine. Are butter and margarine substitutes or complements for this manufacturer?

1. Cross price elasticity is 0.50 and the goods are substitutes.

2. Cross price elasticity is 0.25 and the goods are substitutes.

3. Cross price elasticity is -0.50 and the goods are complements.

4. Cross price elasticity is -0.25 and the goods are complements.

Price Elasticity of Supply

The 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.

Two Extreme Cases of Price Elasticity of Supply

Perfectly Elastic Supply: Price Elasticity of Supply = ∞

0Quantity of pizzas

$12

Price of pizza

S1

Perfectly Inelastic Supply: Price Elasticity of Supply = 0

1000Quantity of cell phone frequencies

$3,000

2,000

Price of cell phone frequency

… leaves the quantity supplied unchanged

S2

At any price above $12, quantity supplied is infinite.

At exactly $12, producers will produce any quantity

At any price below $12, quantity supplied is zero.

An increase in price…

Measuring the Price Elasticity of Supply

Supply is perfectly inelastic when the price elasticity of supply is zero. When changes in the price have no effect on the quantity supplied Supply curve is a vertical line

Supply is perfectly elastic when price elasticity of supply is infinite. When any price change will lead to very large changes in the quantity supplied Supply curve is a horizontal line

What Factors Determine Price Elasticity of Supply?

The 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.

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.

Imposition of a price floors to support the incomes of farmers has created “butter mountains” and “wine lakes” in Europe.

Were European politicians unaware that their price floors would create huge surpluses?

They probably knew that surpluses would arise, but underestimated the price elasticity of agricultural supply.

They thought big increases in production were unlikely since there was little new land available in Europe for cultivation. However, farm production could expand by adding other resources, especially fertilizer and pesticides, which were readily available

So although farm acreage didn’t increase much, farm production did!

European Farm Surpluses

An Elasticity Menagerie

Using the midpoint method, calculate the elasticity of supply for web-design services when the price per hour rises from $100 to $150 and the number of hours transacted increases from 300,000 hours to 500,000. Is supply elastic, inelastic, or unit-elastic?

1. 1.75, elastic2. 1 unit-elastic3. 0.75, inelastic4. 1.25 elastic

True or False? If the demand for milk were to rise, then, in the long run, milk-drinkers would be better off if supply were elastic rather than inelastic.

1. True2. False

True or False? Long-run price elasticities of supply are generally larger than short-run price elasticities of supply. Therefore the short-run supply curves are generally flatter than the long-run supply curves.

1. True2. False

1. True2. False

True or False? When supply is perfectly elastic, changes in demand have no effect on price

Table 5.3 An Elasticity Menagerie (continued)

Tax Incidence – Putting It Together

When the price elasticity of demand is higher than the price elasticity of supply, an excise tax falls mainly on producers.

When the price elasticity of supply is higher than the price elasticity of demand, an excise tax falls mainly on consumers.

So elasticity—not who officially pays the tax—determines the incidence of an excise tax.

The Revenue from an Excise Tax

S

B

60 5,000 10,000 15,000

$140

120

100

80

60

40

20

Quantity of hotel rooms

D

EArea = tax revenue

Excise tax = $40 per room

A

Price of hotel room

The tax revenue collected is:Tax revenue = $40 per room × 5,000 rooms = $200,000

The area of the shaded rectangle is:Area = Height × Width = $40 per room × 5,000 rooms = $200,000

The Revenue from an Excise Tax

The general principle is: The revenue collected by an excise tax is equal to the area of the rectangle(Area = 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.

Tax Rates and Revenue

A tax rate is the amount of tax people are required to pay per unit of whatever is being taxed.

In general, 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.

In some cases, raising the tax rate may actually reduce the amount of revenue the government collects.

Tax Rates and Revenue


Price of hotel room

S

60 ,000 7,50010,000 15,000

$140

120

80

90

70

40

20

D

E

(a) An excise tax of $20

S

0 5,0002,500 10,000 15,000

$140

120

110

80

50

40

20

D

E

(b) An excise tax of $60

Price of hotel room




Area = tax revenue

Are

a =

tax

reven

ue

In 1974. during a conversation with WSJ writer, Jude Wanniski, and the then Deputy White House chief of staff, Dick Cheney, economist Auther Laffer drew a drew a diagram that was intended to explain how tax cuts could sometimes lead to higher tax revenues.

According to Laffer, raising tax rates initially increases revenue but beyond a certain level, revenue will fall as tax rates rise.

In 1981 Ronald Regan used Laffer Cure to argue that his proposed tax cuts would not reduce government tax revenues.

Is there a Laffer Curve? Yes, as a theoretical proposition but very few economists believe that there exists such a high tax rate that reducing it leads to an increase in revenue.

The Laffer Curve

The Costs of Taxation

A fall in the price of a good generates a gain in consumer surplus.

Similarly, a rise in the price generates a loss in consumer surplus .

Excise tax raises the price paid by consumers causing a loss.

Meanwhile, the fall in the price received by producers leads to a fall in producer surplus. Thus a tax reduces both the CS and the PS.

A Tax Reduces Consumer and Producer Surplus

QE Quantity

S

E

D

iprice

QT

PE

PC

PP

C

A B

F

Excise tax = T

Fall in consumer surplus due to tax

Fall in producer surplus due to tax

The Deadweight Loss of a Tax

Consumers and producers are hurt by the tax, but the government gains revenue. The revenue the government collects is equal

to the tax per unit sold, T, multiplied by the quantity sold, QT.

But a portion of the loss to producers and consumers from the tax is not offset by a gain to the government.

The 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.

The Deadweight Loss of a Tax

QE

Quantity

S

E

D

Price

QT

PE

PC

PP

Deadweight loss

Excise tax = T

Cost of Collecting Taxes

The administrative costs of a tax are the resources used by government to collect the tax, and by taxpayers to pay it, over and above the amount of the tax, as well as to evade it.

The total inefficiency caused by a tax is the sum of its deadweight loss and its administrative costs.

The general rule for economic policy is that, other things equal, a tax system should be designed to minimize the total inefficiency it imposes on society.

Deadweight Loss and Elasticities

Quantity

D

E

(a) Elastic Demand

(b)

Inelastic Demand

Quantity

D

S

E

SDeadweight loss is larger when demand is elastic

QE

QE

QT

QT

PE

PC

PP

PE

PC

PP

Excise tax = T

Excise tax = T Deadweight

loss is smaller when demand is inelastic

Price

Price

Figure 5.11 Deadweight Loss and Elasticities

(c) Elastic Supply

(d)

Inelastic Supply

Quantity

Price

D

E

S

Quantity

D

E

S

PE

PC

PP

PE

PC

PP

QE

QE

QT

QT

Excise tax = T

Excise tax = T

Deadweight loss is smaller when supply is inelastic

Deadweight loss is larger when supply is elastic

Price


To minimize the efficiency costs of taxation, one should choose to tax only those goods for which demand or supply, or both, is relatively inelastic.

For such goods, a tax has little effect on behavior because behavior is relatively unresponsive to changes in the price.


When demand is perfectly inelastic (vertical demand curve), the quantity demanded is unchanged by the imposition of the tax. As a result, the tax imposes no deadweight loss.

Similarly, if supply is perfectly inelastic (vertical supply curve), the quantity supplied is unchanged by the tax and there is no deadweight loss.

If the goal is to minimize deadweight loss, then taxes should be imposed on goods and services that have the most inelastic response—goods and services for which consumers or producers will change their behavior the least in response to the tax.

Taxing the Marlboro ManOne of the most important excise taxes in the United States is the tax on cigarettes.

The table above shows the results of big increases in cigarette taxes. In each case, sales fell, just as our analysis predicts. The tax revenue rose in each case because cigarettes have a low price elasticity of demand.

The accompanying table shows five consumers’ willingness to pay for one can of diet soda as well as five producers’ cost of selling one can of diet soda. The government asks your advice about the effects of an excise tax of $0.40 per can of soda. Assume there are no administrative costs from the tax.

Without the excise tax, what is the equilibrium price and quantity of soda transacted?

1. $0.70, 1

2. $0.50, 2

3. $0.40, 4

4. $0.30, 5

The excise tax raises the price paid by consumers to $0.60 and lowers the price received by producers post-tax to $0.20. With the tax, what is the quantity of soda transacted?

1. 12. 23. 44. 5

Without the excise tax, how much individual consumer surplus does each of the consumers gain? How much with the tax? How much total consumer surplus is lost as a result of the tax?

1. $1.00, $.20, $.802. $.60, $.10, $0.703. $.60, $.10, $0.504. $0.40, $.20, $.40

Without the excise tax, how much producer surplus does each of the producers gain? How much with the tax? How much total producer surplus is lost as a result of the tax?

1. $1.00, $.20, $.30

2. $.60, $.10, $0.70

3. $.60, $.10, $0.50

4. $0.40, $.20, $.40

How much government revenue does the excise tax create?

1. $1.002. $0.803. $0.504. $0.40

What is the deadweight loss from the imposition of this excise tax?

1. $0.802. $0.503. $0.404. $0.20

You would expect a tax on gasoline to have a ________ deadweight loss.

1. Small 2. Large

You would expect a tax on milk chocolate bars to have a ________ deadweight loss.

1. Small 2. Large

1. Elasticity is a general measure of responsiveness 2. The price elasticity of demand—the percent change

in the quantity demanded divided by the percent change in the price (dropping the minus sign)—is a measure of the responsiveness of the quantity demanded to changes in the price.

3. The responsiveness of the quantity demanded to price can range from perfectly inelastic demand, where the quantity demanded is unaffected by the price, to perfectly elastic demand, where there is a unique price at which consumers will buy as much or as little as they are offered. When demand is perfectly inelastic, the demand curve is a vertical line; when it is perfectly elastic, the demand curve is a horizontal line.

Summary1 of 5

4. The price elasticity of demand is classified according to whether it is more or less than 1. If it is greater than 1, demand is elastic; if it is less than 1, demand is inelastic; if it is exactly 1, demand is unit-elastic. This classification determines how total revenue, the total value of sales, changes when the price changes.

5. The price elasticity of demand depends on whether there are close substitutes for the good, whether the good is a necessity or a luxury, the share of income spent on the good, and the length of time that has elapsed since the price change.

6. The cross-price elasticity of demand measures the effect of a change in one good’s price on the quantity of another good demanded.

Summary2 of 5

7. The income elasticity of demand is the percent change in the quantity of a good demanded when a consumer’s income changes divided by the percent change in income. If the income elasticity is greater than 1, a good is income elastic; if it is positive and less than 1, the good is income-inelastic.

8. The price elasticity of supply is the percent change in the quantity of a good supplied divided by the percent change in the price. If the quantity supplied does not change at all, we have an instance of perfectly inelastic supply; the supply curve is a vertical line. If the quantity supplied is zero below some price but infinite above that price, we have an instance of perfectly elastic supply; the supply curve is a horizontal line.

Summary3 of 5

9. The price elasticity of supply depends on the availability of resources to expand production and ontime. It is higher when inputs are available at low cost and the longer the time since price change.

10. “Excise taxes” (taxes on the purchase/sale of a good) raise the price paid by consumers and reduce the price received by producers, driving a wedge between the two. The incidence of the tax (how burden of tax is divided between consumers and producers) does not depend on who officially pays the tax.

11. The incidence of an excise tax depends on the price elasticities of supply and demand. If the price elasticity of demand is higher than the price elasticity of supply, the tax falls mainly on producers; if the price elasticity of supply is higher than the price elasticity of demand, the tax falls mainly on consumers.

Summary4 of 5

12. The tax revenue generated by a tax depends on the tax rate and on the number of units transacted with the tax. Excise taxes cause inefficiency in the form of deadweight loss because they discourage some mutually beneficial transactions. Taxes also impose administrative costs—resources used to collect the tax.

13. An excise tax generates revenue for the government, but lowers total surplus. The loss in total surplus exceeds the tax revenue, resulting in a deadweight loss to society. This deadweight loss is represented by a triangle, the area of which equals the value of the transactions discouraged by the tax. The greater the elasticity of demand or supply, or both, the larger the deadweight loss from a tax. If either demand or supply is perfectly inelastic, there is no deadweight loss from a tax.

Summary5 of 5

The End of Chapter 5

Coming attractionChapter 6:

Behind the Supply Curve:Inputs and Costs

Documents

Chapter 4 Elasticity and Taxation ©2010 Worth Publishers Slides created by Dr. Amy Scott