<< Chapter < Page Chapter >> Page >

Elasticity also reveals whether firms can pass higher costs that they incur on to consumers. Addictive substances tend to fall into this category. For example, the demand for cigarettes is relatively inelastic among regular smokers who are somewhat addicted; economic research suggests that increasing the price of cigarettes by 10% leads to about a 3% reduction in the quantity of cigarettes smoked by adults, so the elasticity of demand for cigarettes is 0.3. If society increases taxes on companies that make cigarettes, the result will be, as in [link] (a), that the supply curve shifts from S 0 to S 1 . However, as the equilibrium moves from E 0 to E 1 , these taxes are mainly passed along to consumers in the form of higher prices. These higher taxes on cigarettes will raise tax revenue for the government, but they will not much affect the quantity of smoking.

If the goal is to reduce the quantity of cigarettes demanded, it must be achieved by shifting this inelastic demand back to the left, perhaps with public programs to discourage the use of cigarettes or to help people to quit. For example, anti-smoking advertising campaigns have shown some ability to reduce smoking. However, if demand for cigarettes was more elastic, as in [link] (b), then an increase in taxes that shifts supply from S 0 to S 1 and equilibrium from E 0 to E 1 would reduce the quantity of cigarettes smoked substantially. Youth smoking seems to be more elastic than adult smoking—that is, the quantity of youth smoking will fall by a greater percentage than the quantity of adult smoking in response to a given percentage increase in price.

Passing along higher costs to consumers

These two graphs show how a supply shift affects price and quantity. Figure (a) shows how supply shifts when demand is inelastic and figure (b) shows how supply shifts when demand is elastic.
Higher costs, like a higher tax on cigarette companies for the example given in the text, lead supply to shift to the left. This shift is identical in (a) and (b). However, in (a), where demand is inelastic, the cost increase can largely be passed along to consumers in the form of higher prices, without much of a decline in equilibrium quantity. In (b), demand is elastic, so the shift in supply results primarily in a lower equilibrium quantity. Consumers suffer in either case, but in (a), they suffer from paying a higher price for the same quantity, while in (b), they suffer from buying a lower quantity (and presumably needing to shift their consumption elsewhere).

Elasticity and tax incidence

The example of cigarette taxes showed that because demand is inelastic, taxes are not effective at reducing the equilibrium quantity of smoking, and they are mainly passed along to consumers in the form of higher prices. The analysis, or manner, of how the burden of a tax is divided between consumers and producers is called tax incidence    . Typically, the incidence, or burden, of a tax falls both on the consumers and producers of the taxed good. But if one wants to predict which group will bear most of the burden, all one needs to do is examine the elasticity of demand and supply. In the tobacco example, the tax burden falls on the most inelastic side of the market.

Questions & Answers

why does a firm continue operating at a breakeven point
Prince Reply
to retain its customers for later coming profits.
what economic trend can we expect after lifting of 10 year long sanctions in an national economy?
tesfie Reply
difference between change in demand and change in quantity demanded
Maurice Reply
how to change
For a demand with repect to price. change in demand refers to the shifting of demand curve, where as change in quantity demanded means movement along the given demand curve.
According to lional Robbins how did he explain economics
Raphael Reply
He defined economics as a science which studies human behavior as a relationship between ends and scares which has alternative uses.
What is economics
Nasiru Reply
why are some countries producing inside the ppf
Claire Reply
prove or disprove that balance of trade of trade deficit is a cause of an abnormal demand curve?
Chioma Reply
what's the fixed cost at output zero
Saidou Reply
fixed cost stay the same regardless of the level of output
what are the differences between change in demand and change in quantity demand
Sulaiman Reply
what is consumers behaviour
Marfo Reply
importance of income
Emmanuel Reply
Tfor settlement of debt. For purchases. For payment of bills. For daily transactions. For social & recreational enjoyment. For business purposes etc
For investment purposes For security purposes For purpose of forecasting & strategizing.
what is the real definition of economics
jegede Reply
Economics is the study of the use and allocation of (scarce) resources
Jegede, what is the "non" real definition of economics then?
Economics is a study of how human use limited resources to fulfil their unlimited want
the study of how a society use scarce factors of production efficiently so as meet aggregate social demand
what is oligopoly?
Oligopoly can be defines as a market where by there is only tmo or more sellers of a commodity
Sory not tmo but two
incidence of production there is a choice do you agree? justify
Oduro Reply
What is incidence of production? do u mean incidence of tax?
I want to know about Richard lipsey and robin as the economist and their definition proposed by them
Musa Reply
what are the causes of scarcity And what are the goal scarcity
scarcity only exist because human wants are unlimited...if human just know how to be contented then scarcity will not exist
what is ment by possibility curve
define accounting?teatly
Ahmed Reply
Is the recording, classifying, interpreting record of all transaction
is still the act of measuring, interpreting and communicating of financial issues
measuring business or individual finance
Accounting is the process of collecting,recording,classifying,summarizing and interpreting/presenting financial data to the stakeholders for their economic decision making
wat is PPC

Get the best Principles of economics course in your pocket!

Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
Google Play and the Google Play logo are trademarks of Google Inc.

Notification Switch

Would you like to follow the 'Principles of economics' conversation and receive update notifications?