Demand Elasticity

Discussion on the excerpt from Microeconomics by Jeffrey Perloff, based on “Senate Panel Kills Tax on Luxury Items” (Los Angeles Times, 1992), “The Bottom Line” (New York, 1992), and “Taxes: Tempestin a Yacht Basin” (Time, 1991).

The elasticity of demand, or price elasticity of demand is specifically spoken of in this article.  This price elasticity is defined as the ratio between the percentage changes in quantity demanded with the percentage change in price of a product.  Demand elasticity (as well as supply elasticity) is often broken up into its two major components, inelasticity and elasticity.

Jeffrey Perloff in the article “Tax Revenues from Federal Luxury Taxes” points out a major flaw that sometimes occurs when taxes are being appropriated to specific social levels.  The article explains that an “ad valorem” tax was imposed on many luxury goods in 1990, intending to tax those rich enough to buy luxury goods more than was being taxed to those with less wealth.  It is important to note that policy makers made the judgment that those buying luxury items were more inelastic, or less sensitive to price changes.

These so-called inelastic consumers actually stopped buying yachts and planes, scared because of the extra money needed to spend.  This showed these products were in fact very elastic, and individuals who can afford luxury goods can actually be price sensitive for certain products.

In attempting to avoid harming the poor and middle classes, the “luxury tax” actually proved that the upper class does not have as inelastic of a demand as the government had hoped.  When prices of luxury goods such as yachts, planes, and expensive furs and jewelry began to increase because of the added price of their respective taxes, the consumer market for these items showed elastic demand in their willingness to seek out cheaper substitutes rather than pay more for the same luxury items that they previously would have considered buying.  Strategies for these consumers included buying luxury items at just under the tax level or simply not buying the item at all.

The responses of the consumers of luxury goods proved that even though the income level of the people who would be buying these goods is much higher than the average consumer, their demand can still be elastic if the price does not fit their demand.  The negative effect that the tax had on luxury goods showed that even price hikes among already expensive goods will deter consumers from buying the taxed products.

A real world example of demand elasticity is the gasoline market in the US. Despite rising oil prices, people still buy oil – they need it for daily activities. Casey’s, a convenience store that sells gasoline in the Midwest, remarked that during 2010, when gas prices were changing constantly, they saw no real change in quantity demand for gasoline. As gas prices have risen astronomically in the last 15 years, consumption of gasoline has only grown in the US. Therefore, gasoline is an inelastic good.

Another inelastic good is alcohol. Alcohol is subject to a very stiff excise tax yet consumption of alcohol has not changed heavily in past years. This stands in contrast to tobacco – for years considered an inelastic good – which is now seeing a drop in demand as taxes rise and healthier substitutes (such as nicotine patches) become more readily available. The demand for tobacco has become elastic as the more price increases, the less quantity demanded is for the product.

Posted by John, John and Jason (Section 4)

Resources:

 http://www.caseys.com/media/Caseys_AR_2010.pdf

 http://ecocentric.blogs.time.com/2011/08/16/why-dropping-the-gas-tax-would-be-a-disaster/

 http://www.taxfoundation.org/news/show/245.html

 http://tutor2u.net/economics/revision-notes/as-markets-price-elasticity-of-demand.html

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