Price elasticity is an important idea in microeconomics. It shows how the amount of a product people want (demand) or how much of it is available (supply) changes when the price goes up or down. This concept helps governments make smart choices about taxes, subsidies, and rules for products.

Types of Price Elasticity

1. Price Elasticity of Demand (PED): This tells us how much the amount people want to buy changes when the price changes. We can find it with this formula:

   $$PED = \frac{\% \text{ Change in Quantity Demanded}}{\% \text{ Change in Price}}$$
   • Elastic Demand: If $|PED| > 1$, this means that when the price changes, the amount people want to buy changes a lot. For example, luxury items usually have elastic demand.
   • Inelastic Demand: If $|PED| < 1$, it means that the amount people want to buy doesn't change much when the price changes. Essential items like insulin have inelastic demand, with a PED of about 0.2.

2. Price Elasticity of Supply (PES): This measures how much the amount of a product available changes when the price changes. It can be calculated like this:

   $$PES = \frac{\% \text{ Change in Quantity Supplied}}{\% \text{ Change in Price}}$$
   • Elastic Supply: If $|PES| > 1$, this means that the supply can change a lot when prices change.
   • Inelastic Supply: If $|PES| < 1$, the supply doesn’t change much when prices change. This is often seen in farming products.

Government Policy Applications

1. Taxation: Governments look at price elasticity to guess how taxes will affect products:

   • If a product has elastic demand, raising taxes can cause a big drop in how much people buy, which might reduce tax income.
   • On the other hand, for inelastic items, raising taxes can keep tax income fairly steady. For example, in 2020, the UK made about £14 billion from tobacco taxes, which targeted cigarettes that people still buy even if prices go up.

2. Subsidies: When governments give money to support certain products, the elasticity of demand helps decide how much people will benefit. If a subsidy is given to a product with elastic demand, it can really boost how much of that product is consumed. This is often true for renewable energy products, which usually see a rise in demand when prices drop due to subsidies.

3. Price Controls: Setting maximum prices (price ceilings) or minimum prices (price floors) requires understanding elasticity. For example, during the COVID-19 pandemic, price limits on essential items like hand sanitizers aimed to prevent unfair price hikes but could also cause shortages if the supply is inelastic.

Conclusion

In short, price elasticity is a key part of government decisions. By understanding how demand and supply react to price changes, policymakers can better predict how people will behave, guess tax revenues, and make smart choices about subsidies and price limits. This knowledge is vital for keeping the economy stable and making sure resources go where they are needed in society. Knowing these numbers helps with better planning and decision-making.