Importance of elasticity

In recent times there has been a dramatic decrease in the price of petrol. Petrol can now be purchased for less than £1 per litre. Obviously this has resulted in a large increase in the consumption of petrol and consequently there are now more cars on the road. This has lead to large amounts of congestion and a solution is needed.

One solution is charging for road space. As seen in the diagram to the left this will reduce demand.

Another possible solution is the carbon tax. The purpose of a carbon tax is to internalise the externality. What this means is that the final price of the good should include the external cost and not just the private cost. It is similar to the ‘polluter pays principle.