BackElasticity, Tax Incidence, Surplus, and Market Effects: Midterm 2 Review
Study Guide - Smart Notes
Tailored notes based on your materials, expanded with key definitions, examples, and context.
Elasticity of Demand
Price Elasticity of Demand
The price elasticity of demand measures how much the quantity demanded of a good responds to a change in its price. It is calculated using the midpoint formula:
Elastic demand: Quantity demanded changes significantly with price changes (elasticity > 1).
Inelastic demand: Quantity demanded changes little with price changes (elasticity < 1).
Unit elastic: Percentage change in quantity demanded equals percentage change in price (elasticity = 1).
Formula (Midpoint Method):
Example: If the price of candy bars changes from $1.00 to $0.80 and quantity demanded increases from 500 to 600, use the formula above to determine elasticity.
Total Revenue and Elasticity
Revenue Changes with Price
Total revenue is calculated as price times quantity sold. The effect of a price change on total revenue depends on the elasticity of demand:
If demand is elastic, a price decrease increases total revenue.
If demand is inelastic, a price decrease decreases total revenue.
Graphical Analysis: Rectangles on a price-quantity graph (such as A and D) can represent changes in revenue.
Tax Incidence and Burden
Division of Tax Burden
When a tax is imposed on a market, the burden is shared between buyers and sellers depending on the relative elasticities of supply and demand:
If demand is more inelastic than supply, buyers bear more of the tax burden.
If supply is more inelastic than demand, sellers bear more of the tax burden.
If both are equally elastic, the burden is shared equally.
Example: A $5 per unit tax is imposed; analyze who bears the greater burden using supply and demand elasticities.
Consumer Surplus and Willingness to Pay
Willingness to Pay Table
Consumer surplus is the difference between what a consumer is willing to pay and what they actually pay. The willingness to pay for each unit can be tabulated:
Buyer | First Orange | Second Orange |
|---|---|---|
Allison | $2.00 | $1.50 |
Bob | $1.50 | $1.00 |
Charisse | $0.75 | $0.25 |
Application: If only one orange is supplied, the market price will be set by the highest willingness to pay.
Producer Surplus and Cost Table
Producer Surplus Table
Producer surplus is the difference between the price received and the seller's cost. Sellers with costs below the market price will supply the product.
Seller | Cost |
|---|---|
Abby | $1,000 |
Bobby | $1,150 |
Dianne | $1,200 |
Evaline | $1,250 |
Carl | $1,300 |
Example: If the market price is $1,150, Abby and Bobby would be willing to sell.
Changes in Producer Surplus
Supply and Demand Shifts
When the supply or demand curve shifts, the producer surplus
Tax Effects on Surplus
Consumer Surplus Reduction
When a tax is imposed, consumer surplus
Deadweight Loss and Elasticity
Tax-Induced Deadweight Loss
Deadweight loss is the loss of total surplus due to market distortions such as taxes. The size of deadweight loss depends on the elasticities of supply and demand:
If demand or supply is elastic, deadweight loss is larger.
If demand or supply is inelastic, deadweight loss is smaller.
Graphical Comparison: Comparing graphs with different elasticities illustrates the effect on deadweight loss.
Tariffs and Market Effects
Tariff Imposition
A tariff is a tax on imported goods. Imposing a tariff affects domestic demand and supply, changing consumer and producer surplus and creating deadweight loss.
Graphical Representation: Areas on the graph (A, B, C, D, E, F) show changes in surplus and deadweight loss due to the tariff.
Additional info: These notes expand on brief exam review questions, providing definitions, formulas, and context for key microeconomic concepts relevant to market analysis, elasticity, tax incidence, surplus, and tariffs.
