Price elasticity of demand is the change in demand of a product based on the increase or decrease of the price of that product. It is of significant importance to the government because it is used to determine the tax incidence of each product.
The tax incidence is how the tax imposed on each product is divided between suppliers and consumers. When supply is more elastic (when consumers can substitute one product for another in response to an increase in price), suppliers pay more taxes than consumers. This is also known as inelastic supply. For example, when the price of rice increases, consumers will substitute the rice for a product such as pasta in response to the price change.
When demand is more elastic (when the demand for a product does not change regardless of the price), consumers pay more taxes than suppliers. This is also known as inelastic demand. For example, if the price of gas increases, consumers will still have to purchase gas in order to have transportation for their vehicles. Another example is alcohol. Since alcohol is an addictive substance, the demand for alcohol is unlikely to decrease even with an increase in price.
Most products are impacted by price elasticity. This means that as the price rises, the demand for the product will drop. Also, when the price drops, the demand for the product will rise. Since most items are impacted by price elasticity, the government needs to be aware of the effect of price on the demand for products.
This is important because government actions may impact the price of a product. The government levies taxes on products. These taxes include taxes on imports as well as sales taxes. If either of these taxes is too high, it may impact the consumer demand for the product. If sales taxes are too high, people may buy of these fewer items, which could negatively impact the economy. If taxes on imports are too high, our international trade will also be impacted.
Price elasticity is a factor that governments must consider when developing various economic policies.
Price elasticity of demand seeks to explain how a certain product’s quantity demanded by the market responds to variations in its price. In certain situations consumers have no choice but to purchase a particular product regardless of price increments in what is known as perfect inelastic demand. However, when demand for the product is perfectly elastic the consumers would not purchase and would instead opt for its alternatives.
Price elasticity of demand is thus important to the government because it directly impacts the tax regime of the economy. The government has a responsibility to balance or moderate the tax burden between consumers and producers. This is done to ensure that consumers have access to certain essential products and the producers maintain their ability to provide products and services and ensure profitability. For example, when a government increases taxes on a product exhibiting perfect inelastic demand the burden of the tax falls on the consumers because they have no option but to purchase. However, when the taxes are imposed on products exhibiting perfect elastic demand then the tax burden falls on the producers since they cannot pass it on to the consumers.
Price elasticity of demand is mainly of interest to the government for the purposes of taxation. Governments in most places impose sales taxes or value-added taxes. These sorts of taxes raise the price of goods and services to which they apply.
Governments need to know the price elasticity of demand for these goods and services so they can know the likely impact of the tax. If the demand for hotel rooms (for example) is very inelastic, then the government can increase the sales tax on hotel rooms without creating a situation where hotels lose business and tax revenues fall. Governments will not want to raise sales taxes on items that are very elastic. Therefore, governments need to know about pirce elasticity of demand.