PRINCIPLES OF MICROECONOMICS

MAY / 2018

BBEK1103

NO. MATRIKULASI : 831209145612001

NO. KAD PENGNEALAN : : 831209145612
NO. TELEFON : 0162305487
E-MEL : emilyn@oum.edu.my

PUSAT PEMBELAJARAN : PETALING JAYA

1. INTRODUCTION TO THE CONCEPT OF ELASTICITY

Elasticity is the numerical characteristic of the change in one indicator showing how much the
first indicator will change when the second one changes by 1%. As reiterated by Puan Hamidah
Ramlan, elasticity can be defined as the sensitivity measurement of a particular variable (for
example, quantity demanded or quantity supplied) towards change in one of its determinants (for
example, price or income).

The economic definition of elasticity was first given by A. Marshall in 1885. A well-known
English scientist did not invent this concept, but using the achievements of English classics (A.
Smith and D. Ricardo) and the mathematical school in economic theory, gave a definition of the
coefficient of price elasticity of demand. The most common definition of the coefficient of
elasticity is the ratio of the relative increment of the function to the relative increment of the
independent variable

Introduction to the concept of "elasticity" in economic analysis was of great importance. On the
one hand, the elasticity coefficient is a tool of statistical measurements, including actively used
in marketing research (consulting firms in the US take from $ 50 to $ 75 thousand for calculating
elasticity for private firms). On the other hand, the concept of elasticity serves as an important
tool for economic analysis, because in science it is not enough just to measure, it is also
necessary to be able to explain the result obtained.

To show how responsive quantity demanded is to a change in price, we apply the concept of
elasticity. The price elasticity of demand for a good or service, eD, is the percentage change in
quantity demanded of a particular good or service divided by the percentage change in the price
of that good or service, all other things unchanged. Thus we can write

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2. DESCRIPTION OF TAX

Malaysia is a very tax friendly country. Income tax comparably low and many taxes which are
raised in other countries, do not exist in Malaysia. Taxation is the method by which a
government gains revenue to spend on things like public services and welfare benefits

1. Direct taxes collected by Inland Revenue Board

 Income taxes on corporations and individuals

 Petroleum (PITA)
 Stamp Duty
 Real Property Gain Tax (RPGT)
 Estate Duty

2. Indirect taxes collected by Royal Customs and Excise Department

 Import duties
 Export duties
 Excise duties
 Sales tax
 Service tax

Other than that, our country also has non tax revenue:

Major components:

 Petronas Dividend
 Petroleum Royalty and Gas
 Road tax
 Bank Negara Dividend
 Revenue from:
 Issuance of licenses and permits
 Fines and penalties
 Proceeds from sale of government assets
 Rental of government property

The benefits and costs of both forms of taxation are many. Taxation is required in a civilized
society to provide for goods and services the private sector cannot provide profitably. The
administration of these needs is also funded by taxation. Taxes also redistribute wealth between
taxpayers and individuals who receive government assistance.

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3. RELATIONSHIP BETWEEN TAX AND ELASTICITY

Depending on the circumstance, the burden of tax can fall more on consumers or on producers.
The analysis of how the burden of a tax is divided between consumers and producers is called
tax incidence.

Typically the burden of a tax falls both on the consumers and producers of the taxed good. But if
we want to predict which group will bear most of the burden, we can examine the elasticity of
demand and supply. If demand is more inelastic than supply, consumers bear most of the tax
burden. But, if supply is more inelastic than demand, sellers bear most of the tax burden.

When demand is inelastic, consumers are not

very responsive to price changes, and the
quantity demanded remains relatively
constant when the tax is introduced.

Placing a tax on a good, shifts the supply

curve to the left. It leads to a fall in demand
and higher price. However, the impact of a tax
depends on the elasticity of demand. If
demand is inelastic, a higher tax will cause
only a small fall in demand. Most of the tax
will be passed onto consumers. When demand
is inelastic, governments will see a significant increase in their tax revenue.

Consumer burden of tax rise

The consumer burden of a tax rise, measure the extra amount consumers actually pay. In the
above graph example, the specific tax is $6. The price rises from $10 to $14 so the consumer
burden is $4 (x) 80. Total consumer burden is $320

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Producer burden of tax rise

The producer burden is the decline in revenue from the tax. In the above example, producers
used to receive $10, but now after the tax is paid, they are left with $8 per unit. The total
producer burden is $2 (x) 80) = $160

Tax revenue for government

The total tax revenue for the government is $6 x 80 = $480

Effect of Tax on Elastic Demand

If demand is elastic, then an increase in price

will lead to a bigger percentage fall in
demand. In this case, the producer burden is
greater than the consumer burden. The tax
will be more effective in reducing demand,
but less effective in raising revenue for the
government The total tax revenue for the
government is $6 x 50 = $300

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Comparison of inelastic and elastic demand

In diagram A, above on the left, the supply is inelastic and the demand is elastic. By introducing
a tax, the government essentially creates a wedge between the price paid by consumers (Pc), and
the price received by producers (Pp). In other words, of the total price paid by consumers, part is
retained by the sellers and part is paid to the government in the form of a tax. The distance
between Pc and Pp is the tax rate. The new market price is Pc, but sellers receive only Pp per unit
sold since they pay Pc - Pp to the government.

The tax revenue is given by the shaded area, which is obtained by multiplying the tax per unit by
the total quantity sold, Qt. The tax incidence on the consumers is given by the difference
between the price paid, Pc, and the initial equilibrium price, Pe. The tax incidence on the sellers
is given by the difference between the initial equilibrium price, Pe, and the price they receive
after the tax is introduced, Pp

In diagram A, above on the left, the tax burden falls disproportionately on the sellers, and a
larger proportion of the tax revenue—the shaded area—is due to the resulting lower price
received by the sellers than by the resulting higher prices paid by the buyers.

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In diagram B—above on the right— the supply is more elastic than demand. The tax incidence
now falls disproportionately on consumers, as shown by the large difference between the price
they pay, Pc, and the initial equilibrium price, Pe. Sellers receive a lower price than before the
tax, but this difference is much smaller than the change in consumers’ price.

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4. SUMMARY

In this paper we have the explained the concept of elasticity, described the types of taxes
available in our country and discussed the relationship between tax and elasticity. Price elasticity
of demand measures how responsive consumers are to changes in the price of a product. It is the
ratio of the percentage change in quantity demanded to the percentage change in price. Tax
revenue on the other hand is the income gained by governments through taxation.

To explain the relationship between tax and elasticity we have use the elasticity pricing graph.
Using this type of analysis, we have discover that when supply is more elastic than demand,
consumers will bear more of the burden of a tax than producers will. For example, if supply is
twice as elastic as demand, producers will bear one-third of the tax burden and consumers will
bear two-thirds of the tax burden. When demand is more elastic than supply, producers will bear
more of the burden of a tax than consumers will. For example, if demand is twice as elastic as
supply, consumers will bear one-third of the tax burden and producers will bear two-thirds of the
tax burden.

We can also predict whether a tax is likely to create a large revenue or not. The more elastic the
demand curve, the easier it is for consumers to reduce quantity instead of paying higher prices.
The more elastic the supply curve, the easier it is for sellers to reduce the quantity sold instead of
taking lower prices. In a market where both the demand and supply are very elastic, the
imposition of an excise tax generates low revenue.

People often think that excise taxes hurt mainly the specific industries they target. But ultimately,
whether the tax burden falls mostly on the industry or on the consumers depends simply on the
elasticity of demand and supply.