Chapter 10 Applications of Elasticities

Chapter 10 Applications of Elasticities

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Chapter 10 – applications of elasticities(Week 7 & 8)

Objectives of the chapter
Applications / •DefineTR and calculate from data and/or diagrams
•Explain how TR changes due to taxes, subsidies. (Link PED to exports and imports.)
•Explain why govt might tax certain goods more than others - link to govt tax revenue.
•Explain why some goods fluctuate in price more than others. Explain how PED for X and M affect trade.
•Identify and draw how changes in D and/or S will affect Q and/or P more or less depending on PED and PES
•Explain why firms (say for luxury items) would benefit from understanding yED over a business cycle.
•Evaluatethe effects of low PED on GDP for LDCs and why such commodity producers get hit hard due to low PED for their goods. /
  1. Define: TR, tax revenue, export revenue, import expenditure
  2. Describe/outline:how TR changes over a D-curve,
  3. Explain/distinguish/draw: why govts tax certain goods, why prices might fluctuate more for certain goods, how D changes due to a change in income for normal and inferior goods, link between income and demand for certain goods (inferior/normal)
  4. Evaluate/discuss: how Q might not change so much for tobacco and alcohol when govts try to “tax them away”, how LDCs are effected by producing goods with low PED

Note that we have covered most of the content in this chapter earlier. However, since repetition is the mother of knowledge…

Three main areas of application for elasticities:

1)PED

  1. Firms and TR (P x Q)
  2. Import and exports revenue
  3. Govt and taxes
  4. Price fluctuations (when PED is low prices fluctuate more)

2)PES

  1. Issue of how quickly firms can respond to changes in demand
  2. Oil
  3. DVDs
  4. Price fluctuations and PES (see oil)
  5. Price fluctuations and links to commodity producing LDCs (Indonesia!)

3)yED

  1. changes in income and planning production (say RR cars and wheat)
  2. how exporters of secondary goods (MDCs) have seen demand increase more than exporters of primary goods (LDCs) as incomes have grown

In all cases above you must know at least two key determinants of elasticity. Time and subst’s for PED and PES, necessities or luxuries for yED.

Revision questions:

  1. Rev-max and whether the price should be raised or lowered in order to attain it. If P is at level where PED > 1…lower P. If P is…opposite (greater than 1)…raise the P.
  2. What goods should govts tax?
  3. Why do they tax certain goods more than others?
  4. Any faulty logic herein?! (Yes.)
  5. Why prices tend to fluctuate more for inelastic goods than for elastic goods.
  6. If PED is low…a change in S will cause a greater movement in P than for a good with high PED
  7. If PES is low…etc…
  8. Which goods might be more sensitive to the business cycle! For example, demand for yachts and pasta will differ over cycles.
  9. During an upturn (e.g. high economic growth where income rise…Dpasta will not increase as much as Dyachts)
  10. For example, why is steel so strongly linked to the business cycle? (Clue; the demand for steel is derived from the demand for….)
  11. Dsteel is derived from the demand for goods such as ‘fridges…cars…etc, all of which are income elastic
  12. Is there a link between the business cycle and demand for corn?
  13. Yes, a link, albeit somewhat weak…positive but low value of yED. Corn is a necessity and will not react that much to a change in income.
  14. What happens to PED for any given good when new firms enter the market?
  15. PED will become greater – more substitutes means that existing firms’ goods will become more price sensitive.
  16. Why do LDCs that produce primary goods suffer so much due to low PED for their goods?
  17. Price volatility builds in insecurity for firms – hard for them to see how much to produce…how much to invest for the future!
  18. What has happened to Sprim-goods over past 50 years?
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