The demand for oil is very inelastic in the short run, but becomes more elastic in the long run. The supply of oil is more elastic than the demand for oil in the short run. The supply elasticity also increases in the long-run, but by a lesser degree than the elasticity of demand increases. If a tax of $5 per barrel of oil is imposed on oil producers: a. In the short run, the incidence of the tax will fall mainly on oil consumers and the net deadweight loss to the economy will be relatively small, but in the long run, the incidence of the tax will shift more towards oil producers, although the oil consumers will still effectively pay for most of the tax, and the net deadweight loss to the economy will be larger than in the short run. b. In the short-run, the incidence of the tax will fall mainly on oil consumers and the net deadweight loss to the economy will be relatively large, but in the long run, the incidence of the tax will shift more toward oil producers, although the oil consumers will still effectively pay most of the tax, and the net deadweight loss to the economy will be smaller than in the short run. c. In the short run, the incidence of the tax will fall mainly on oil producers and the net deadweight loss to the economy will be relatively large, but in the long run, the incidence of the tax will shift more toward oil consumers, although the oil producers will still effectively pay for most of the tax, and the net deadweight loss to the economy will be smaller than in the short run. d. In the short run, the incidence of the tax will fall mainly on oil producers and the net deadweight loss to the economy will be relatively small, but in the long run, the incidence of the tax will shift more toward oil consumers, although the oil producers will still effectively pay most of the tax, and the net deadweight loss to the economy will be larger than in the short run. Stalla says that a is correct. But i think the correct answ is b
Konstantin, ‘A’ looks correct to me too, Since consumer-demands are more inelastic to oil in the short-run, they need to pay the most of the statutory tax (so options C and D are out), and since the demands are inelastic, the plot is almost vertical causing the dead-weight-loss triangle to suppress from the ‘demand side’ (so the Net deadweight loss to the economy will be relatively small, so option B is out) and get converted to a scalene-triangle from the original equilateral-triangle. - Dinesh S
Seconded. I think DWL dwindles as curves become less elastic.
dinesh.sundrani thanks for answer. I understand that inelastic demand cause a bigger share of taxe imposed. But i dont understand why the net deadweight loss to the economy will be relatively small?With respect to what? With respect to long run deadweight? As so i dont understand why!!!.. Plese help.
Like I said, DWL will be smaller compared to when the curves are more elastic (i.e. long run). Less elastic curves = smaller deadweight loss. D-curve for example is less elastic in the short run, because we’re keeping amount of technology fixed, so the consumers have not found any substitutes to oil; so they depend on oil, no matter what the price is, therefore the d-curve is inelastic. Picture the graph, draw inelastic curves and see what the DWL is. Then draw the same curves, but with a smaller slope (i.e. flatter) and see what happens to the DWL. It becomes larger.
Konstantin Wrote: ------------------------------------------------------- > dinesh.sundrani thanks for answer. I understand > that inelastic demand cause a bigger share of taxe > imposed. > But i dont understand why the net deadweight loss > to the economy will be relatively small?With > respect to what? With respect to long run > deadweight? As so i dont understand why!!!.. > Plese help. Just play around with the graph and you will see the magic 1. Plot an equilibrium P-Q curve, shade the DWL 2. Now make supply curve a bit steep (inelastic) and shade the DWL. Which took you less lead (carbon) to shade? Probably the 2nd one, right? Economics is all about confusion and graphs… - Dinesh S
dinesh.sundrani Wrote: ------------------------------------------------------- > Economics is all about confusion and graphs… LOL, that’s intro eco though. Try modelling all this with equations only. I guarantee you it gets much trickier then I know a lot of people on this forum are confused and even dislike economics. But if you really take the time to nail the basics (how you label the graphs, what they tell you, what drives what, etc.), which is not rocket science by any means, you’ll be in a very good position to answer the overwhelming majority of questions thrown at you. 'There’s usually a recurring theme, so take the time to learn it well, then reap the benefits. For example, the graph on LAS, SAS and AD, and what happens when SAS and AD shift is probably shown 15 times in the notes in a slightly different context each time. That’s definitely something worth spending time on.
It helped for me to reread the section in CFAI that deals with this issue (Reading 15 page 75): “In the extreme cases of perfectly inelastic demand and perfectly inelastic supply, a tax does not change the quantity bought and sold and there is no deadweight loss. The more inelastic is either demand or supply, the smaller is the decrease in quantity and the smaller is the deadweight loss. When demand or supply is perfectly inelastic, the quantity remains constant and no deadweight loss arises.”
So Im still do not understand why when S and D are more steeper (inelastic) the DWL is smaller? So lets design a plot: 1) Draw S and D where D is more steeper (inelastic) 2) Shift S up and left - draw S1 - (5$ Tax +) So we see DWL where the most part is imposed on consumer because of inelastic demand Thats right. 3) Then rotate initial D line counterclockwise to make it more elasic (more flat). 4) Then rotate shifted supply line S1 clockwise (more flat) afte 3 and 4 steps You will see that DWL will shrink and that is inline a common sense that the economics is adapted and redistribute resources more effectively? Please tell me where i’m wrong
Anybody! Please I cant sleep :)!
I’ll look at it later today.
I’ve realized my error. When i was rotating demand curve to make it more elastic i didn’t shifted the equilibrium quantity to the right. But why should i shift this point (qty demanded to the right)?
I think the correct answer is A because since supply is more elastic it will change with outside changes, in this case it will increase prices to reflect the new tax.Consumers on the other hand can’t say tommorrow I won’t drive to work (short term inelasticity) but can say I’ll buy a hibrid car if prices are up for 2-3 years. The deadweight thing translates to me to the fact that producers incorportate the new tax in the prices and consumers can’t reduce that consuption that rapidly, therefore the impact on the total sales is minimum On the long term even if prices will still incorporate the tax, consumers will choose not to consume that much which will affect producers (supply) and will create a reduction in consumption (deadweight)
Konstantin, I thought about the best way to explain this, and I think I’ll adopt a less graphical and a more intuitive approach. I hope this will clear things up for you and it will also help you understand not so much how but why the graphs are moving the way they do and what really happens. As a result, if we get a question like that, you won’t have to have memorized the answer but understand it and be prepared to analyze the situation. It’s really simple. So we know that market forces allocate resources efficiently. In other words, if we leave supply and demand alone, do not impose taxes, there are no external costs, etc, the productive capacity in the economy will produce that quantity of a certain good or service, that maximizes the sum of consumer and producer surplus. However, when we impose a tax, we distort this equilibrium, i.e. the quantities produced and demanded are no longer the optimal quantities, because producers and consumers now have their choices altered by the new tax. Let’s take this a step further and figure out what happens when the demand and supply curves have different elasticities. What happens when those curves have lower elasticities? It simply means that the tax has not done as much damage, i.e. a tax is levied, but the consumers and producers have NOT responded as much by changing the quantities they demand and supply, i.e. they have not moved very far from the original equilibrium determined by market forces (which is the efficiant allocation). On the other hand, when the curves are more elastic, MORE resources are allocated to other (inefficient) uses and the damage is that much bigger. Think of damage as an increase in the deadweight loss. Does that help?
Lola thanks conceptually i understand well that the more inelastic - the less quantity change - the less the DWL. But as a mathematician i need to see the graphical (formal) evidence. So could you analyse my steps in graphical representation of the problem please? First we have D1 S1 curvses and Q0 and P0 eq. point. After tax is imposed we have D1 S2 curves P1>P0 and Q1Q0 so we seen that DWL is greater (ultimate triangle is larger than in the short-run)
Hey Fellows could anybody check my logic please? Thanks
Lola I’ve realized youe explanation completely. Thank You But, please analyze my logic in graphic reperesenation of the situation