Microeconomics

Session 4

Sagnik Bagchi, Ph.D.

School of Business Management, NMIMS-Mumbai

Elasticity in Short-Run and in the Long-Run

Short-run is defined as the amount of time that does not permit a full adjustment by
consumers to a price change.

 Each of the short-run demand curves is rather inelastic

 Original position is at a (represented by price p1 and
quantity demanded Q1, (DS1). As price rise to p2 demand falls
to Q2
 As time passes, consumer adjust to substitutes, a new short
run demand curve emerges (DS2). Demand will take place at
point c representing a large decrease in quantity.

Over-time adjustment permits movement to another short-

run curve, and a long-run demand curve is created.

18/07/2023 Microeconomics-MBA Core [2023-24], SB 2

Demand Elasticity and Revenue
Total Revenue (TR) = PQ
Marginal Revenue (MR) =
Average Revenue (AR) =

Price Quantity Total Revenue Elasticity

10 1 10
9 2 18
Elastic
8 3 24
7 4 28
6 5 30
Unitary-Elastic
5 6 30
4 7 28
3 8 24
Inelastic
2 9 18
1 10 10

18/07/2023 Microeconomics-MBA Core [2023-24], SB 3

Demand Elasticity and Revenue

Elastic Unit Elastic Inelastic

Price Increase TR decreases No change in TR TR increases
Price Decrease TR increases No change in TR TR decreases

18/07/2023 Microeconomics-MBA Core [2023-24], SB 4

Price Ceiling

Demand Supply

Pc

Q1 Q0 Q2

Price ceiling indicates that the price of a product cannot be sold at a higher rate than that is set as a
price ceiling

Price ceiling creates a shortage. In the above illustration, with P c being price ceiling a shortage of Q 2 –
Q1 is established.

18/07/2023 Microeconomics-MBA Core [2023-24], SB 5

Price Floor
Demand Supply

Pf
P

Q1 Q0 Q2

Price floor indicates that the price of a product cannot be sold at a lesser rate than that is set as a price
floor

Price floor creates a surplus. In the above illustration, with P f being price floor, a surplus of Q2 – Q1 is
established.

18/07/2023 Microeconomics-MBA Core [2023-24], SB 6

Incidence of Tax: Specific Tax [Excise Tax]
Specific Tax: A fixed amount of tax placed on the quantity of good

Say, the government collects the tax from the sellers. Then the amount will depend on the supply price,
the price that the seller actually receives after paying the tax, and the amount demanded will depend on
the demand price the price that buyers actually pay

Qd = 10 – P; Qs= P

At equilibrium, Qd = Qs and Pd = Ps; P = 5 and Q =5

As tax (t) of Rs. 0.1 per unit is imposed on sellers which means that P s = Pd – 0.1.

Qd = 10 – Pd; Qs= Pd – 0.1; We will have the same demand curve but a new supply curve

In equilibrium, Qd = Qs; 10 – Pd = Pd – 0.1

Pd = 5.05; Ps = 4.95

Note that even though sellers have to pay a tax of Rs. 0.1 but the price paid has just gone up by 0.05
paise.
18/07/2023 Microeconomics-MBA Core [2023-24], SB 7
Incidence of Tax: Specific Tax [Excise Tax]
Demand Supply
Demand Supply

5.05 The supply curve shifts

5 upward. The new supply
4.95 curve is Qs= P-0.1

5 4.95

Sellers will receive Rs. 4.95 and buyers will pay Rs. 5.05. The difference of Rs. 0.1 goes to government.
Tax burden is shared equally between seller and buyer. But that is not always the case.

Incidence of tax is distributed based on the elasticity of demand and supply. For instance, the more
elastic the demand curve more burden of tax on supplier has to bear.

If the tax is imposed on buyers then the demand curve shifts downward and Ps = Pd + t

18/07/2023 Microeconomics-MBA Core [2023-24], SB 8

Controlling Traffic in City Centers
Case in Singapore: Motorist must purchase prepaid cash cards and tolls are deducted electronically
from this card. The tolls differ depending on the time of the day the car enters a city.

If a car enters the city without the card then a violation notice will be mailed. As a result of this program
traffic has been decreased by 17% and the speed at which cars pass through the city has increased.

Case in Minneapolis: One of the greatest employers American Express Financial Advisors is subsidizing
the area’s bus system in return for greatly reduced monthly bus tickets for its employees.

In Singapore, the action has increased In Minneapolis, a substitute for car commuting
cost of travel and has caused movement has been established. The demand curve for auto
along the demand curve. travel will now shift to the left, a decrease in
demand.

18/07/2023 Microeconomics-MBA Core [2023-24], SB 9