Ch. 5 Sec. 5

# Ch. 5 Sec. 5 - chapter 5 > Elasticity Section 5: Using...

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>> Elasticity Section 5: Using Elasticity: The Incidence of an Excise Tax chapter 5 We’ve just run through quite a few different elasticities. Keeping them all straight can be a problem. So in Table 5-2 we provide a summary of all the elasticities we have dis- cussed and their implications. In Chapter 4 we introduced the concept of the incidence of a tax—the measure of who really bears the burden of the tax. We saw in the case of an excise tax—a tax on sales or purchases of a product—that the incidence does not depend on who literally pays the money to the government. It doesn’t matter, in other words, whether the tax is assessed on the sellers or the buyers. But we also noted that to determine who real- ly pays the tax, we need the concept of elasticity. We are now ready to see how the price elasticity of demand and the price elastic- ity of supply determine the incidence of an excise tax.

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2 CHAPTER 5 SECTION 5: USING ELASTICITY: THE INCIDENCE OF AN EXCISE TAX TABLE 5-2 An Elasticity Menagerie Name Possible values Significance Price elasticity of demand = % change in quantity demanded % change in price Perfectly inelastic demand 0 Price has no effect on quantity demanded (vertical demand curve). Inelastic demand Between 0 and 1 A rise in the price increases total revenue. Unit-elastic demand Exactly 1 Changes in the price have no effect on total revenue. Elastic demand Greater than 1, A rise in the price reduces total less than revenue. Perfectly elastic demand A rise in price causes quantity demanded to fall to 0. A fall in price leads to an infinite quantity demanded (horizontal demand curve). Cross-price elasticity of demand = % change in quantity demanded % change in price of another good Complements Negative Quantity demanded of one good falls when the price of another rises. Substitutes Positive Quantity demanded of one good rises when the price of another rises. (use absolute value)
3 CHAPTER 5 SECTION 5: USING ELASTICITY: THE INCIDENCE OF AN EXCISE TAX TABLE 5-2 (continued) An Elasticity Menagerie Name Possible values Significance Income elasticity of demand =

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## This note was uploaded on 04/13/2010 for the course ECON 1110 taught by Professor Wissink during the Fall '06 term at Cornell.

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Ch. 5 Sec. 5 - chapter 5 > Elasticity Section 5: Using...

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