 |  Principles of Microeconomics, 1st Canadian Edition Robert H. Frank,
Cornell University
Ben S. Bernanke,
Princeton University
Lars Osberg,
Dalhousie University
Melvin Cross,
Dalhousie University
Brian MacLean,
Laurentian University
Demand: The Benefit Side of the Market
Graphing ExercisesExtending the Text Economic Naturalist 5.6 asks whether increased taxes will curb teen smoking. The analysis goes as follows: Some argue that taxes will have very little effect on teen smoking since teens tend to smoke because their peers do and price will not affect this peer pressure. However, most teens do not have a great deal of disposable income and, as a result, their demand tends to be fairly price sensitive, or elastic. As a result an increase in the price of cigarettes will likely cause at least some of them to cut back or quit smoking altogether. This reduction in the number of smokers will reduce the number of role models others see and the peer pressure will not be as great. So it may be the case that an increase in taxes will reduce teen smoking overall. To take this to the next level, let's look at how such a change in tax might affect not only the level of smoking, but also the level of revenue generated to tobacco companies. (Who must then pass on the amount of the tax to the taxing agency—the tobacco companies don't get to keep it all!) |
| | 1. | Beginning with the existing graph pair, the price of cigarettes is $3 and the quantity sold is 3000 per week for $9000 in total expenditure. If we pass a tax, which increases the price of cigarettes by 50 cents (use the green triangle to drag the Price up to $3.50 from $3.00 and watch the "Price = X" in the box to determine when you are exactly on $3.50), what will the resultant change in revenue to the seller be? (Remember that the revenue to the seller is the amount the seller receives minus any amount they must pass on to the taxing agency.)
See our suggested answer. |
| | 2. | Now, suppose the demand for cigarettes is more elastic than in the original example. Click the Reset button to return to the original situation and then increase the elasticity of demand at the current price of $3.00. To do this you need to flatten the demand curve by dragging the D out to the right. So that we are all "on the same page," for this example drag the Quantity-Intercept out from 6 to 7. (To tell when you are precisely at an intercept of 7, watch the Elasticity = X section of the box. When the elasticity is 1.33 at a price of $3.00, the intercept is at 7.) How will a tax that results in a 50-cent increase in the price of cigarettes affect the firm's revenue now?
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| | 3. | Under which of these demand structures will the tax be most effective? Which one is the seller likely to support?
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| On Your Own: Suppose the conventional wisdom IS correct.
What if the demand for cigarettes among teenagers is relatively inelastic—how will this affect the revenue gained by shop-owners from a tax that increases the price of cigarettes by 50 cents a pack?
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| | 4. | To begin your analysis, click the icon above to open a new window containing an interactive demand-total expenditure (revenue) model or, if the window is already open, click the reset button. Beginning from the original starting point, but with a more inelastic demand, what will be the impact on revenue to shop-owners from the 50-cent increase in the price of cigarettes due to a tax?
See our suggested answer. |
| Question to Think About... The relationship between revenue and elasticity is an extremely important one. From this notion we can make better decisions about a wide array of issues. For example:
- Why might it be the case that business people are adamantly against some types of taxes and willing to tolerate others?
- In our efforts to "protect" our workers from foreign competition (more on that issue in later chapters) why is it important to determine the elasticity of demand for a product BEFORE deciding to impose a tariff?
- As we ask ourselves questions about pricing the products we create and sell, how might elasticity be useful in making decisions?
- If you "squint and look at it just right," you will see that one of the objectives of marketing and advertising is to make the demand for a particular product more INELASTIC. Using this mechanism you should be able to see why this is the case.
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2003 McGraw-Hill Higher Education