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In the long run, would the deadweight loss caused by the increased gasoline tax grow larger or
smaller? Why?
If the federal government decides to increase the gasoline tax by $2 per gallon, will this cause a
larger or smaller deadweight loss than a 50 cent per gallon increase? Why?
Study Guide for Chapter 17
Chapter Summary for Chapter 17
Elasticity is a measure of the responsiveness of one variable to changes in another variable.
Price elasticity of demand measures the relative sizes of the changes in quantity demanded and
price. Price elasticity of demand is calculated as the percentage change in quantity demanded
divided by the percentage change in price. The common practice is to treat changes as absolute
values and arrive at a positive answer. When demand is perfectly inelastic, the quantity
demanded is unchanged by a change in price, and the demand curve is vertical. When demand is
perfectly elastic, the demand curve is horizontal.
In computing price elasticity of demand, the percentage change in quantity demanded is
calculated by dividing the change in quantity demanded by the average quantity demanded. The
percentage change in price is calculated by dividing the change in price by the average price.
If E D is greater than one, demand is elastic, and price and total revenue are inversely related. If
E D is less than one, demand is inelastic, and price and total revenue are directly related. If E D
equals one, demand is unitary elastic, and a change in price does not change total revenue.
The determinants of price elasticity of demand are the factors that determine whether the demand
for a good is elastic or inelastic. The four determinants of price elasticity of demand are; (1) the
number of substitutes for the good, (2) the percentage of a person’s budget spent on the good,
(3) nature of the good; luxury versus necessity, and (4) time consumers have to respond.
Income elasticity of demand measures the responsiveness of demand to a change in income. In
computing income elasticity of demand, the percentage change in quantity demanded is divided
by the percentage change in income. The percentage changes are calculated the same as for
price elasticity of demand, except that it is necessary to calculate the changes as positive
(increase) or negative (decrease). Income elasticity is positive for normal goods and negative for
inferior goods. For normal goods, an income elasticity of demand greater than one would indicate
a luxury good. An income elasticity of demand less than one would indicate a necessity.
Cross elasticity of demand measures the responsiveness of demand for one good to a change in
price for another good. In computing cross elasticity of demand, the percentage change in
quantity demanded for one good is divided by the percentage change in price for the other good.
The percentage changes are calculated the same as for income elasticity of demand, and once
again it is necessary to calculate the changes as positive or negative. Cross elasticity is positive
for substitutes and negative for complements.
Price elasticity of supply measures the relative sizes of the changes in quantity supplied and
price. Price elasticity of supply is calculated as the percentage change in quantity supplied
divided by the percentage change in price. In computing price elasticity of supply, the percentage
changes are calculated in the same manner used in computing price elasticity of demand. The
biggest factor affecting price elasticity of supply is time.
The relative burden of a tax depends on the price elasticity of demand and supply. Buyers bear a
greater burden of a tax if supply is more elastic than demand. Sellers bear a greater burden of a
tax if demand is more elastic than supply.
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17 - 13 Elasticity