Discuss the significance of price elasticity of demand for government intervention in

markets

Price elasticity of demand is a measure of the responsiveness of a quantity of a good

demanded to changes in its price. In the example of a tax or subsidy, It will affect who pays
most of the tax or receives the greatest benefit from the subsidy. First I will explore the
impact of a tax on cigarettes as cigarettes are a good that the government would want to
intervene to decrease consumption of, a demerit good.
1. Tax on cigarettes: 2. demerit good cigarette diagram with tax:

A tax pushes the supply curve left as it is an increase in the cost of producing per unit. A tax
on rice pushes the price form P1 to P2 A tax on an inelastic good will result in the price going
up more of the tax can be pushed on consumers as they have to pay P2-P1 whereas
producers pay P1-P3. In an inelastic demand curve, an increase in price will lead to an
increase in total revenue. This is because inelastic demand curves represent goods called
necessities which you have to buy or, in the case of staple foods you buy it or you die
however in the case of cigarettes, they are addictive forcing you to consume more even if
the price changes this keeps the quantity demanded fairly unresponsive to price shifts and
constant. A tax on cigarettes would increase the income of the producer and the tax
revenue of the government this has resulted in cigarettes being hugely taxed in countries
like the UK as the government attempts to eliminate the welfare loss caused by smoking
which is the MEC shown on diagram 2 which creates the shaded in welfare loss with the tax
attempting to reduce Qfm to Qso with the tax pushing the price to Ptax. However, it is
exceptionally hard to quantify the welfare lost in the diagram as it is difficult to put numbers
on the increased likelihood of disease and the damage second hand smoke can cause to
bystanders, this makes it difficult for the government to intervene with an appropriate tax.
Another way in which price elasticity affects government intervention is a subsidy on rice.
3. subsidy on rice
The government would want to subsidies rice as rice is a staple food which the lower
income households eat, therefore putting a subsidy on it, with it being an inelastic demand
curve, will result in a large reduction in price form P1 to P2 which is important as the lower
income households are more price sensitive therefore it will be effective in reducing income
inequality. There is a large gain in consumer surplus of D,E and a gain in consumer surplus
A,B with only C being a small welfare loss. It also increases the income of farmers who are
often some of the poorest labourers in society as they now receive a price of P3. It also
allows farmers to increase the number of farmhands employed as they need more quantity
supplied this results in a reduction in rural unemployment. The total cost is (P3-P2)*Q2.
I will also explore the elastic demand curve of fast food:
4. fast food elastic demand tax 5. Demerit good with tax

Fast food would be taxed by the government as it is a demerit good with MEC’s like more
time off work due to heart related diseases. However in the case of an inelastic demand
curve being taxed are a loss in total revenue and most of the tax has to be shouldered by
producers as the quantity demanded is far more responsive to a change in price. As shown
on diagram