EQ: What is Price Elasticity of Supply?

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1 EQ: What is Price Elasticity of Supply? Price Elasticity of Supply (ES) is a characteristic of a product describing: The degree of change in quantity supplied by producers when there is a change in price. Price Elasticity of Supply: When supply is more elastic, suppliers have the production capacity to be able to increase quantity supplied a lot when the price goes up. When supply is less elastic, suppliers have less production capacity and are able to only increase quantity supplied a little when the price goes up.

2 EQ: How Do I Calculate Price Elasticity of Supply? Price Elasticity of Supply (ES) is a measure of the change in quantity supplied relative to different market prices for a good. Formula: Change in Quantity Supplied Average Quantity Supplied Change in Price Average Price *See the textbook Chapter 17 for an example on how to calculate Price Elasticity of Supply.

3 EQ: How Do I Calculate Price Example: Elasticity of Supply? When the price of ipods increases from $400 to $450, Apple is willing to increase production from 600 units to 750 units daily. What is the price elasticity of supply? Q2 Q (Q2 + Q1)/2 ( )/ % ES = = 1.88 P2 P % (P2 + P1)/2 ( )/2 425

4 EQ: How Do I Calculate Price Elasticity of Supply? ES will always have a positive value because there is always an increase in supply when there is an increase in price (Law of Supply). Supply is generally more elastic in the long run and less elastic in the short run. In the long-run, suppliers can respond to price changes by moving to a new building, financing high-cost equipment, and changing capacity, making the supply curve more flexible. In the short-run, suppliers usually can only change the number of employees, making the supply curve less flexible.

5 Impact of Taxation refers to the party on which a tax is levied (the person who sends the money to the government agency). The party who carries the impact of the tax is not always the one who carries the burden of the tax. Burden of Tax the party that, in the end, experiences the tax that is levied. Tax Shifting when the party being levied a tax is able to shift the burden of that tax onto someone else. Incidence of Taxation the reduction in real income that people experience after a tax has been shifted to them.

6 Here s how it works: The government decides to tax a product, like gasoline. Sellers of gasoline (refineries and gas stations) experience the impact of taxation. Refineries and gas stations raise the price of gas so that consumers pay a portion of the tax instead of the suppliers paying the whole tax. Through tax shifting, consumers are now taking on a portion of the burden of taxation. Because consumers are now paying more for gas due to the new tax, they have less money to spend on other things. This is called incidence of taxation.

7 The degree to which a tax can be shifted depends on the price elasticity of supply and the price elasticity of demand. This means that elasticity will affect: Who carries the burden of taxation, and How much of an incidence of taxation consumers and sellers will experience. We will now look at how elasticity of supply and demand affect tax shifting and the burden of taxation.

8 Process of Tax Shifting: 1. The Government Imposes a Tax 2. Supply decreases due to the tax increasing production costs (added cost for the business). 3. The supply curve shifts to the left. 4. Equilibrium price increases The amount of the price increase is the amount of the tax that is shifted to consumers. The amount not shifted is the tax burden of the sellers. 5. Also, equilibrium quantity will decrease, so sellers will get less revenue due to the tax imposed. 6. The incidence of taxation is the money lost by both buyers and sellers due to the tax.

9 $ S 1. After the government imposes a $2 tax 2. Supply decreases due to an increase in production costs and 3. The supply curve shifts to the left. $1 tax shift $5 $4 4. Equilibrium price increases $2 tax impact S 6. The incidence of taxation for: -Buyers $1 x 80 = $80 less to spend. -Sellers: a. Used to get $400 in real revenues. b. Now get $400 in revenues. -Must pay 80 x $2 in tax impact. -Real revenues are $ Equilibrium quantity decreases D Q

10 $ S S 1. After the government imposes a $2 tax 2. Supply decreases due to an increase in production costs and 3. The supply curve shifts to the left. No tax shift. $ Because demand is perfectly elastic, equilibrium price does not change $2 tax impact 5. Equilibrium quantity decreases Q Perfectly Elastic Demand and Tax Burden D 6. The incidence of taxation for: -Buyers no incidence of taxation. -Sellers: a. Used to get $400 in real revenues. b. Now get $240 in revenues. -Must pay 60 x $2 in tax impact. -Real revenues are $120.

11 $2 tax shift $ D $6 $ Equilibrium price increases 100 Q Perfectly Inelastic Demand and Tax Burden S $2 tax impact S 1. After the government imposes a $2 tax 2. Supply decreases due to an increase in production costs and 3. The supply curve shifts to the left. 6. The incidence of taxation for: -Buyers $2 x 100 = $200 less to spend. -Sellers: a. Used to get $400 in real revenues. b. Now get $600 in revenues. -Must pay 100 x $2 in tax impact. -Real revenues are $400. -No incidence of taxation. 5. Because demand is perfectly inelastic, equilibrium quantity does not change.

12 $ $6 1. After the government imposes a $2 tax 2. Supply decreases due to an increase in production costs and 3. The supply curve shifts to the left. S $2 tax shift 4. Equilibrium price increases $2 tax impact $ Q Perfectly Elastic Supply and Tax Burden S 5. Equilibrium quantity decreases 6. The incidence of taxation for: -Buyers $2 x 50 = $100 less. -Sellers: a. Used to get $400 in real revenues. b. Now get $300 in revenues. -Must pay 50 x $2 in tax impact. -Real revenues are $200. -$200 incidence of taxation. D

13 $ S S Perfectly Inelastic Supply Curves Don t Shift When Costs Increase 0 D Q

14 $ S 1. The government imposes a $2 tax 2 & 3. But there is no change in supply because supply is inelastic. No tax shift $4 4. Because there is no change in Supply, there s no change in equilibrium price. 6. The incidence of taxation for: -Buyers no incidence of taxation. -Sellers: a. Used to get $400 in real revenues. b. Now get $400 in revenues. -Must pay 100 x $2 in tax impact. -Real revenues are $ Because there is no change in Supply, there s no change in equilibrium quantity. 100 Q Perfectly Inelastic Supply and Tax Burden D

15 Based on these graphs, we can say: Buyers carry a larger portion of the burden of tax when: Demand is less elastic, or Supply is more elastic. Sellers carry a larger portion of the burden of tax when: Demand is more elastic, or Supply is less elastic.