Price Elasticity Essay
Using the calculation of: price elasticity of demand= (percentage change in quantity)/(percentage change in price) When the percentage change in the quantity that is demanded is greater than the percentage change in the price, the resulting absolute value of the calculation will be greater than 1. The first two products, Barnes and Noble books and Coca-Cola, will therefore have an elastic demand classification.
When the percentage change in the quantity that is demanded is less than the percentage change in the price, the resulting absolute value of the calculation will be less than 1. The last three products of Cigarettes, Beer, and Gasoline; will therefore have an inelastic demand classification. (R. Glen Hubbard, 2012) Explain the implications of those classifications on tax revenue collections when the per-unit tax increases as opposed to decreases. When the products are inelastic, an increase in price from the higher duty will lead to a small decrease in demand which is not enough to offset the higher tax that is raised on each unit. Basically, tax revenue collections will therefore rise.
The tax revenue collections will fall when that price decreases. They move in the same direction. When the products are elastic, an increase in price from the higher duty would lead to a fall in tax revenue collections. Alternately, when the price decreases, it would lead to a rise in the tax revenue collections. The relationship here is an inverse one. (R. Glen Hubbard, 2012) Using those classifications, make some assumptions regarding tax incidence.
For instance, will buyers or sellers pay a larger portion of the tax per unit? Explain. If the product is price inelastic to the consumer (if price rose, a small demand loss would be accounted for by the extra revenue), the seller is able to pass the entire or most of the burden of the tax on to the buyer. The tax incidence here falls on the buyer. If the seller is unable to raise prices because the product is price elastic (if prices rose, more demand would be lost than extra revenue gained), the seller then has to bear the burden of the tax or face decreased revenues.
The tax incidence here falls to the seller. In this scenario, the burden would likely continue to flow further back to the factors of production.
Conclude, based on the elasticity classifications, their effect on tax revenue and tax incidence, and which goods the government would prefer to tax. The government would prefer to tax products that are usually inelastic. The reason for this is that the quantity demanded of inelastic goods is proportionally smaller than the increase or decrease in the change in price…they are less responsive. Therefore the government will place taxes on these goods and they will acquire higher tax revenues.
The seller basically does not care that much as they simply place most of the burden of these taxes onto the buyer. Bibliography
R. Glen Hubbard, A. P. (2012). Microeconomics, 3rd edition. Upper Saddle River: Prentice Hall. Wikipedia. (2013, April 6). Tax Incidence. Retrieved 9 21, 2013, from http://en.wikipedia.org/wiki/Tax_incidence