PED Formula Results Factors   Shows us the relationship between a change in price and a change in quantity demanded for a product. If the % change in price is smaller than the % chaange in quantity demanded, the product is elastic. If the % change in price is larger than the % change in quantity demanded, the product is inelastic. PED = % Change in Quantity Demanded % Change in Price   If the result is less than 1: this means the product is price inelastic. The closer it is to 0, the more inelastic it is What this thus tells us is that a change in price results in a smaller change in quantity demanded e.g. if price rose by 10%, quantity demanded would fall by - say - 5% If the result is more than 1: this means the product is elastic. The further from 1 it is, the more elastic it is What this tells us is that a change in price results in a smaller change in quantity demanded e.g. if price rose by 10%, quantity demanded would fall by - say - 20% If the result is exactly 1: this means the product is unitary elastic What this tells us is that a change in price results in an identical change in quantity demanded e.g. if price rose by 10%, quantity demanded would fall by 10% Time Subsititutes Definition Relationship with other goods Initial Income Original Price   If the product Content 4

YED Formula Results Factors Measures the responsiveness of Demand for one good, when incomes change If the % change in income is higher than the % change in Demand then the good is Income inelastic If the % change in income is higher than the % change in Demand then the good is Income elastic Content 2 Content 3 Content 4

CED Formula Results Factors Cross Elasticity of Demand (CED or XED) Measures the responsiveness of Demand for one product to a change in price for another If the % change in Demand for Good X is positive then the Good is a substitute good If the % change in Demand for Good X is negative then the product is a complementary good Content 2 Content 3 Content 4

PES Formula Results Factors Price Elasticity of Supply (PES) Measure the relationship between a change in price for a product, and a change in its quantity supplied (QS) If the % change in price for the product is smaller than the % change in QS, the product is supply elastic If the % change in price for the product is greater than the % change in QS, the product is supply inelastic Content 2 Content 3 Content 4

Knowing the Price Elasticity of Demand and Supply for our product is very useful for the government too. By working it out, they can decide on how much tax to charge. Let's look at the first diagram.

Demand here is price inelastic (<1). What happens then, when a tax - (remember, tax is a determinant of supply and thus shifts it inwards because it is more expensive to produce) - is placed on the product?

Now let's have a look at what happens if demand is price elastic (>1) and we put that tax on:

 

Clearly in this example we lose 30% of our product for 10% incraese in price. Q1xP1 is thus smaller than Q2xP2. Whilst the government does till get tax, this tax is lower than for an inelastic good.

What about if we wanted to find out who was affected most by these taxes? We call this the tax burden - the section of society that pays for most of the tax. In an ideal world for producers, if the government put a 10% tax on a good, then they would charge 10% more for their product. They would actually then pay none of the tax, the consumer would pay it all. But to do this, their PED would have to be perfectly inelastic... unlikely.

The way we calculate where the burden of tax falls is simple.
Draw in P1 and Q1. Then draw in the effect of the tax (S-S1). Then, at the new equilibrium (marked A) draw a dotted line down to the original supply (B). The difference betwen A and B is the value of the tax (if you want to know why, it's because it shows us our marginal costs - but don't worry about this!). But B is lower than the original price. This area (green) is thus the amount of tax the producer pays. The difference between P1 (original price) and the new equilibrium price (which you can label P2) is the amount of tax WE pay.

 

 

 

 

 

 

 

 

 

The rule here is simple:

When demand is price inelastic and a flat rate tax is imposed, the greater the consumer burden of tax- we say that the incidence of tax falls on the consumer.

When demand is price elastic and a flat-rate tax is imposed, the greater the producer burden - we say that the incidence of tax falls on the producer.

The more inelastic the product, the more the consumer pays the burden of tax and vice-versa.

Coming soon, due to popular demand!