Question 1: A Level H1 2011 Governments frequently impose direct taxes in order to influence the pattern of consumers expenditure.

The effectiveness of such policy measures, however, depends crucially on how consumers respond. (a) Explain with the help of examples the concepts of price elasticity of demand and price elasticity of supply. Introduction Define Elasticity Elasticity is a measure of the responsiveness of quantity demanded or quantity supplied to a change in one of the determinants, ceteris paribus. There are four concepts of elasticities and this essay will focus on the concepts of price elasticity of demand(PED) and price elasticity of supply(PES). While the latter indicates the consumers responsiveness of quantity demanded of a good to changes in its price, the former indicates the sellers responsiveness of quantity supplied of a good to changes in its price. PED measures the degree of responsiveness of quantity demanded of a good to changes in its price, ceteris paribus. There are five degrees of PED ranging from 0 to . A good with PED of magnitude 0 is said to be perfectly price inelastic in demand a price change would lead to 0 responsiveness in quantity demanded. A good with PED of magnitude between 0 to 1 is price inelastic in demand. A change in price leads to a less than proportionate change in quantity demanded. A good with PED of 1 is unitary price elastic in demand any change in price leads to a proportionate change in quantity demanded. A good with PED between 1 to is price elastic in demand as a change in price would lead to a more than proportionate change in quantity demanded of the good. Lastly, a good thats perfectly price elastic in demand has a PED of - any slight change in price leads to infinitely large changes in quantity demanded. Determinants The PED of a good can be influenced by a few factors. of PED The more close substitutes a good has, the more price elastic in demand it would be as consumers can easily switch to substitutes when price of the good rises. For

Point 1 Define PED Degrees of PED

example, HL milk tends to be price elastic in demand as there are various substitutes to which consumers can change to. The more widely defined a good is, the lesser substitutes it tends to have and there it tends to be more price inelastic in demand. For example, food tends to be price inelastic in demand whereas noodle tends to be more price elastic in demand. The higher the proportion of income spent on the good, the more price elastic in demand the good tends to be. Consumers would be more forces to cut down on consumption when the price goes up. For example, when the price of housing goes up, consumers would delay buying a new house and therefore houses are said to price elastic in demand. However, when the price of tissue paper goes up, it will only be a slight increase, which is generally affordable, and therefore the quantity demanded is not significantly impacted. Tissues papers are price inelastic in demand. The longer the adjustment period, the more price elastic in demand. Firstly, the consumers have a greater ability to substitute away to lower-priced substitutes. There is more time for the price change to be known and for consumers to adjust their consumption pattern. Secondly, there is more scope for substitutes to be found or developed. The nature of good also determines the PED of the good. A necessity tends to be more price elastic in demand. Food is a need and even if the price were to go up, people would still buy it. However, if the price of holidays were to increase, people would postpone their trip. Food is more price inelastic in demand whereas holidays are more price elastic in demand. Habit-forming goods tend to be price inelastic in demand. Point 2 Define PES Degrees of PES PES measures the degree of responsiveness of quantity supplied of a commodity to changes in its price, ceteris paribus. There are five degrees of PES ranging from 0 to . A good with PES of magnitude 0 is said to be perfectly price inelastic in supply a price change would lead to 0 responsiveness in quantity supplied. A good with PES of magnitude between 0 to 1 is price

inelastic in supply. A change in price leads to a less than proportionate change in quantity supplied. A good with PES of 1 is unitary price elastic in supply any change in price leads to a proportionate change in quantity supplied. A good with PES between 1 to is price elastic in supply as a change in price would lead to a more than proportionate change in quantity supplied of the good. Lastly, a good thats perfectly price elastic in supply has a PES of - any slight change in price leads to infinitely large changes in quantity supplied. Determinants of PES

Question 1: A Level H1 2011 Governments frequently impose direct taxes in order to influence the pattern of consumers expenditure. The effectiveness of such policy measures, however, depends crucially on how consumers respond. (b) Discuss the view that Government efforts to intervene in the working of the free market through indirect taxation inevitably create more problems than they solve. Introduction Why the government intervenes and how it intervenes Governments have both micro and macro economic objectives. The main microeconomic objectives are to ensure that there is an efficiency in allocation of resources and equity in wealth and income distribution while the main macroeconomic objectives are to achieve a high economic growth, a low inflation rate, low levels of unemployment and a long term BOP and exchange rate. However there are instances when these objectives cannot be achieved and the government would intervene to reduce the problems. This could be done through various means like imposition of taxes and bans, regulations and tariffs. Indirect taxation eliminates the problem of a negative externality. Negative externality is the cost that is borne by a third party who is neither the consumer nor the producer of the good for which no compensation was made. To solve this a Pigovian tax is imposed to the producer.

Taxation Point one Thesis

The free market originally consumes at Qf. A tax equal to the negative externality is imposed by the government. There is internalization of the externality. This causes the firms MPC to shift up to MPC*. As a result of this, firms produces where their new MPC*=MPB. The socially allocation efficient output is achieved and the deadweight loss eliminated.

Anti Thesis

For negative externalities during production, There is a divergence between MPC and MSC. A tax on production would shift the MPC upwards by the amount of tax. The tax on production would shift the MPC upwards by the amount of tax. The tax forces the firm to internalize the externality. If the tax is equal to the negative externality, it would result in production at Q*. However, indirect taxation used to solve negative externalities also results in other problems. The higher the external cost, the higher the tax per unit. For the tax to be effective, it must equate to the negative externality at the socially optimal output. A tax that is smaller than the negative externality would not eliminate the problem fully. A tax that is too high for the negative externality would result in wastage of resources, which could have been used to produce something else. It is also hard for the government to estimate the amount of externality.

Point two