EXPLAIN WHY IT IS CRUCIAL THAT POLICY MAKERS HAVE ACCURATE ESTIMATES OF THE RELEVANT DEMAND ELASTICITIES WHEN DECIDING ON A POLICY SCHEME, FOR EXAMPLE FUEL TAXATION

Authors Avatar
"EXPLAIN WHY IT IS CRUCIAL THAT POLICY MAKERS HAVE ACCURATE ESTIMATES OF THE RELEVANT DEMAND ELASTICITIES WHEN DECIDING ON A POLICY SCHEME, FOR EXAMPLE FUEL TAXATION"

- - - - - - - - - - -

CATHERINE ROBINS

03008113

- - - - - - - - - - -

ALEXANDROS ZANGELIDIS

THURSDAY, 12 - 1pm

INTRODUCTION

Businesses and governments alike use the concept of elasticity of demand. By looking at demand elasticities, it is possible to predict how consumers will react to a change in the price of a good. It is therefore vital for sellers in helping to assess what may happen to profits and/or market share as a result. For governments, elasticity of demand is imperative when making taxation decisions. For example, would a rise in indirect tax on cigarettes lead to a rise in total tax receipts? Will a rise in road tax cause any significant reduction in car usage, and a fall in negative externalities such as congestion? The answers to such questions can have a huge impact on governments' budgets. An increase in taxation on some goods will result in increased tax revenue, whereas on others tax revenue will decrease. The key is to establish which goods will result in an increase in revenue and implement suitable actions accordingly.

To begin with, we need to define price elasticity of demand. Price elasticity of demand (PED) measures the responsiveness of a change in demand for a good to a change in its price. When price falls we expect to see an expansion in demand, and when price rises we expect to see a contraction in demand. There is therefore an inverse relationship between price and demand, which gives a negative value for PED. To avoid confusion, we ignore the negative sign and focus simply on the coefficient of elasticity. PED is calculated by the following formula:
Join now!


This calculation gives a value which indicates a commodity's price elasticity. For instance, if PED is zero, we say demand is perfectly inelastic - quantity demanded does not change at all as price changes; if PED is between zero and 1, demand is inelastic - quantity demanded changes by a smaller percentage than price; if PED is equal to 1, demand is unit-elastic - quantity demanded and price change by the same percentage; if PED is greater than 1, demand is elastic - quantity demanded changes by a larger percentage than the change in price; and if PED ...

This is a preview of the whole essay