Applications of Elasticity Concepts (Govt)

• Equilibrium price


  The price at which the quantity demanded equals the quantity supplied
• Equilibrium quantity


  The quantity at which the quantity demanded equals the quantity supplied
• Total revenue or total expenditure


  The total amount spent by consumers on a good or service
• Consumer Expenditure


  Total Expenditure = Price x Quantity
• Price Elasticity of Demand (PED)


  Helps to analyse the extent of change in price and quantity when there is a change in supply, and the direction and extent of change in consumer expenditure/total revenue when there is a change in supply
• Increase in market supply

  Leads to a rise in total revenue if the demand is inelastic
• Increase in market supply

  Leads to a fall in total revenue if demand is price inelastic
• Price Elasticity of Supply (PES)


  Helps to analyse the extent of change in price and quantity when there is a change in demand
• Rise in demand


  Leads to a rise in equilibrium price and quantity, which leads to a rise in total revenue/expenditure
• PES is not useful to determine the directional change in Expenditure/Revenue
• A rise in demand would raise equilibrium price and quantity and hence most definitely raise expenditure/revenue, and vice-versa
• Income Elasticity of Demand (YED)


  Used to analyse the extent of change in Total Revenue in a market when there is a change in Income
• Cross Price Elasticity of Demand (XED)

  Used to analyse the extent of change in Total Revenue in a market when there is a change in Price of Related good
• Government intervene in markets for several reasons
• Reasons for government intervention

  • Discourage or prohibit production or consumption of a certain good
  • Minimise social harm, prevent depletion of resources
  • Encourage the production or consumption of a certain good
  • Raise revenue
  • Make certain good more affordable
  • Safeguard the interest of producers
• Variables to examine when analysing the effects of government intervention

  • Consumer expenditure
  • Consumer surplus
  • Producer revenue
  • Producer surplus
• Goods that are harmful to consumers' health include tobacco, alcohol, and unhealthy foods
• Goods that are harmful to third parties include alcohol leading to accidents, plastic bags causing pollution, motor vehicles causing environmental pollution, and greenhouse gas emissions from factories
• Indirect tax


  A tax levied on goods and services, e.g. sales tax (GST)
• Deadweight loss


  A cost to society created by market inefficiency, which occurs when supply and demand are out of equilibrium
• Basic effects of a tax on the market

  1. Equilibrium price rises

  2. Equilibrium quantity falls

  3. Increased tax revenue (accruing to government)
• Indirect tax reduces both the consumption and production of the good
• The more price inelastic the demand, the greater the burden of tax on buyers
• The more price inelastic the supply, the greater the burden of tax on sellers
• Generally, the party that is less responsive to price changes will bear a higher burden of the tax
• Quota


  An upper limit on the quantity of a good that can be bought or sold
• Basic effect of a quota on the market

  1. Equilibrium price rises

  2. Equilibrium quantity falls

  3. Allocative inefficiency arises (deadweight loss)
• Moral suasion


  The use of persuasion rather than coercion or legislation, to influence the activity of consumers
• Subsidy


  A form of financial aid or support extended to firms or consumers with the aim of promoting an economic objective
• Basic effect of a subsidy on the market

  1. Equilibrium price falls

  2. Equilibrium quantity rises

  3. Increase in government expenditure due to subsidy
• Price ceiling


  A legally established maximum price that is set below the equilibrium price
• Black market


  An illegal market that exchanges goods at a price above the legally established maximum price
• The more price elastic the demand and supply, the larger the shortage created by a price ceiling, which would encourage the formation of black markets
• The more price elastic the demand and supply, the larger the deadweight loss in the market when a price ceiling is imposed
• A price ceiling must be set below the equilibrium price to be effective
• Price floor


  A legally established minimum price that is set above the market equilibrium price
• The more wage elastic the demand and supply of labour, the larger the unemployment created by a minimum wage
• The more price elastic the demand and supply, the larger the surplus created by a price floor, which would encourage the formation of black markets
• A price floor must be set above the equilibrium price to be effective