Elastic and Inelastic Demand

Topics: Pollution, Supply and demand, Externality Pages: 4 (1250 words) Published: May 9, 2012
Task 1
The rice market is our product concerned in this assignment. As a pantry necessity for the Asians, the rice market has an inelastic demand. Also, it has no close substitutes or perfect substitutes. This makes the importance of rice inevitable. On the other hand, the rice market has an elastic supply. Due to the wide variety of rice provided in the market, the quantity supplied by sellers tends to respond substantially to slight changes in price.

Assume an equal value of tax is placed on the consumption and production of rice market. In order to clearly present the surpluses and government revenue, a welfare analysis is shown below. As shown in the analysis, the negative difference of –B-C in consumer surplus and –D-E in producer surplus indicates that both consumers and producers are worse off. The –C-E in total surplus represents the deadweight loss, causing buyers consuming less and sellers producing less.

The burden of tax is shared between buyers and sellers of rice market (Mankiw, 2007). In the diagram, it shows the distance between POand PB is greater than POandPS, signifying the price of buyers pay is more than the price sellers receive. Plus, the burden of tax tends to fall on the side of the market which is less elastic, in this case, the consumer. This again concretes the fact that buyers have a greater burden in bearing the taxation than sellers of rice market. There is no government revenue in a free market. After a tax is imposed, +B+D displays the increase of government revenue collected from buyers and sellers of rice market.

The change in total welfare comprises changes in consumer surplus(negative), producer surplus(negative), government revenue(positive) and total surplus(negative) demonstrates that the reduction of both surpluses exceeds the government revenue of +B+D, showing the government is the only party who is better off. The overall social welfare is reduced as a result of taxation distorts incentives. (320 words)

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