THE ELASTICITY OF DEMAND

Consumers usually buy more of a good when its price is lower when their incomes are higher when the prices of substitutes for the good are higher or when the prices of complements of the good are lower. Our discussion of demand was qualitative not qualitative. That is we discussed the direction in which quantity demanded moves but not the size of the change. To measure how much consumers respond to change in these variables, economists use the concept of elasticity.

The Price Elasticity of Demand and Its Determinants

The law of demand states that a fall in the price of a good raises the quantity demanded. The price elasticity of demand measures how much the quantity demanded responds to a change in price. Demand for a good is said to be elastic if the quantity demanded responds substantially to change in the price. Demand is said to be inelastic if the quantity demanded responds only slightly to change in the price.

The price elasticity of demand for any good measures how willing consumers are to move away from the good as its price rises. Thus the elasticity reflects the many economic social and psychological forces that shape consumer tastes. Based on experience however we can state some general rules about what determines the price elasticity of demand.

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RENT CONTROL IN THE SHORT RUN AND LONG RUN

One common example of a price ceiling is rent control. In many cities the local government places a ceiling on rents that landlords may charge their tenants. The goal of this policy is to help the poor by making housing more affordable. Economists often criticize rent control arguing that it is a highly inefficient way to help the poor raise their standard of living. One economists called rent control the best way to destroy city other than bombing. The adverse effects of rent control are less apparent to the general population because these effects occur over many years. In the short run landlords have a fixed number of apartments to rent and they cannot adjust this number quickly as market conditions change. Moreover the number of people searching for housing in a city may not be highly responsive to rents in the short run because people take time to adjust their housing arrangements. Therefore the short-run supply and demand for housing are relatively inelasti...

Why Did OPEC Fail to Keep the Price of Oil High

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Elasticity and Tax Incidence

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CAN CONGRESS DISTRIBUTE THE BURDEN OF PAYROLL TAX

If you have ever received a paycheck you probably noticed that taxes were deducted from the amount you earned. One ot these taxes is called FICA an acronym for the Federal Insurance Contribution Act. The federal government uses the revenue from the FICA tax pay for Social Security and Medicare the income support and healthcare programs for the elderly. FICA is an example of a payroll tax which is a tax on the wages that firms pay their workers. In 2005 the total FICA tax for the typical worker was of earnings. Who do you think bears the burden of this payroll tax firms or workers. When Congress passed this legislation it tried to mandate a division of the tax burden. According to the law half of the tax is paid by firms and half is paid by workers. That is half of the tax is paid out of firms revenues and half is deducted from workers paychecks. The amount that shows up as a deduction on your pay stup is the worker contribution. Our analysis of tax incidenc...

The Variety of Demand Curves

Economists classify demand curves according to their elasticity. Demand is elastic when elaelsticity is greater than 1, so that quantity moves proprotionately more than the price. Demand is inelastic when the elasticity is less than 1, so that quantity moves proprotionately less than the price. If the elasticity is exactly 1, so that quantity moves the same amount proprotionately as price demand to have unit elasticity. Because the price elasticity of demand measures how much quantity demanded responds to change in the price, it is closely related to the slope of the demand curve. The following rule of thumb is a useful guide. The flatter the demand curve that passes through a given point the greater the price elasticity of demand. The steeper the demand curve that passes through a given point, the smaller the price elasticity of demand. In the extreme case of a zero elasticity, shown in panel demand is perfectly inelastic and the demand curve is vertical. In thi...

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