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Elasticity also reveals whether firms can pass higher costs that they incur on to consumers. Addictive substances tend to fall into this category. For example, the demand for cigarettes is relatively inelastic among regular smokers who are somewhat addicted; economic research suggests that increasing the price of cigarettes by 10% leads to about a 3% reduction in the quantity of cigarettes smoked by adults, so the elasticity of demand for cigarettes is 0.3. If society increases taxes on companies that make cigarettes, the result will be, as in [link] (a), that the supply curve shifts from S 0 to S 1 . However, as the equilibrium moves from E 0 to E 1 , these taxes are mainly passed along to consumers in the form of higher prices. These higher taxes on cigarettes will raise tax revenue for the government, but they will not much affect the quantity of smoking.

If the goal is to reduce the quantity of cigarettes demanded, it must be achieved by shifting this inelastic demand back to the left, perhaps with public programs to discourage the use of cigarettes or to help people to quit. For example, anti-smoking advertising campaigns have shown some ability to reduce smoking. However, if demand for cigarettes was more elastic, as in [link] (b), then an increase in taxes that shifts supply from S 0 to S 1 and equilibrium from E 0 to E 1 would reduce the quantity of cigarettes smoked substantially. Youth smoking seems to be more elastic than adult smoking—that is, the quantity of youth smoking will fall by a greater percentage than the quantity of adult smoking in response to a given percentage increase in price.

Passing along higher costs to consumers

These two graphs show how a supply shift affects price and quantity. Figure (a) shows how supply shifts when demand is inelastic and figure (b) shows how supply shifts when demand is elastic.
Higher costs, like a higher tax on cigarette companies for the example given in the text, lead supply to shift to the left. This shift is identical in (a) and (b). However, in (a), where demand is inelastic, the cost increase can largely be passed along to consumers in the form of higher prices, without much of a decline in equilibrium quantity. In (b), demand is elastic, so the shift in supply results primarily in a lower equilibrium quantity. Consumers suffer in either case, but in (a), they suffer from paying a higher price for the same quantity, while in (b), they suffer from buying a lower quantity (and presumably needing to shift their consumption elsewhere).

Elasticity and tax incidence

The example of cigarette taxes showed that because demand is inelastic, taxes are not effective at reducing the equilibrium quantity of smoking, and they are mainly passed along to consumers in the form of higher prices. The analysis, or manner, of how the burden of a tax is divided between consumers and producers is called tax incidence    . Typically, the incidence, or burden, of a tax falls both on the consumers and producers of the taxed good. But if one wants to predict which group will bear most of the burden, all one needs to do is examine the elasticity of demand and supply. In the tobacco example, the tax burden falls on the most inelastic side of the market.

Questions & Answers

Explain Effective demand
Anita Reply
What is effective demand
Anita
like Modi is in demand...best example of effective demand
Pranav
Don't get you
Anita
Anita you mean you don't get me or who?
Onyeking
level of demand that represents a real intention to purchase by people with the means to pay
Pranav
what are differences between perfect competition and oligopoly
Chafah Reply
what is balance of payment
Tih Reply
I don't know
Somkenechukwu
balance of payment is the sum total of a country receipt for her exports and the total payments made for her imports.
dajan
discuss collusion of An oligopoly
Fikile Reply
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henry Reply
what is money
Ngea Reply
money is everything
Pranav
a regulatory object between producer and consumer of monetary system
Vipul
money is anything generally accepted for the payment of goods and services and for the settlement of debt
Angel
a regulatory object of good and services between producer and consumer ( all these comes under monetary system)
Vipul
what is price surveillance?
Berry Reply
what is favourable balance of trade
Ngea
what is demand
Oluchi Reply
Wat is effective demand
Anita
It's the level of demand that represents a real intention to purchase by people with the means to pay.
Onyeking
what are two classical macroeconomics and what're their theories say about their equations?
AMARA Reply
what is the formula for calculating elasticity
aza Reply
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Umar
what is elasticity of demand?
Rita Reply
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Osanday
hi
SHERO
flexibility of demand in terms of price , income and tax ratio .
Vipul
Causes of economic growth
pierre Reply
What is elasticity of demand
pierre
What are the causes of economic growth
pierre
economic growth, establishment of industry, encourage of investor's, farm productivities, creation of institutions, construction of good road etc
Oyewale
elasticity of demand can be said to be the responsiveness of demand to a change in prices
fateemah
impact of collusion in the economy referring to inefficiencies illustrated by means of graph
nondumiso Reply
The Factor price will determine the choice of techniques to produce.Expantiate
dajan
what is elasticity of demand?
Etta Reply
state and explain two types of demand
Etta
Institution involved in money market
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Source:  OpenStax, Principles of economics. OpenStax CNX. Sep 19, 2014 Download for free at http://legacy.cnx.org/content/col11613/1.11
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