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Governments often have multiple objectives in imposing a tax. In each part of this question, use a demand and supply graph to illustrate your answer. a. If the government wants to minimize the excess burden from excise taxes, should these taxes be imposedon goods that have price-elastic demand or on goods that have price-inelastic demand? b. Suppose that rather than minimizing excess burden, the government is most interested in maximizing the revenue it receives from the tax. In this situation, should the government impose excise taxes on goods that have price- elastic demand or on goods that have price-inelastic demand? c. Suppose that the government wants to discourage smoking and drinking alcohol. Will a tax be more effective in achieving this objective if the demand for these goods is price elastic or if the demand is price inelastic?

Short Answer

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a. If the government aims to minimize the excess burden from excise taxes, these should be imposed on goods that have price-inelastic demand. b. If the government is interested in maximizing the revenue it receives from the tax, it should impose excise taxes on goods with price-inelastic demand. c. If the government wants to discourage consumption of certain goods, a tax will be more effective if the demand for these goods is price elastic.

Step by step solution

01

Define Price Elasticity and Inelasticity

Price elasticity of demand measures the responsiveness of the quantity demanded to a change in the price of a good. If the quantity demanded changes significantly in response to price changes, demand is said to be elastic. If it changes very little, demand is inelastic.
02

Taxes and Price-elastic demand

If the government aims to minimize the excess burden of excise taxes, it would choose to tax goods with an inelastic demand. The excess burden of taxation falls more on the side of the market that is less elastic, meaning that consumers or producers are less able to respond to the tax by changing the quantity they buy or sell. Thus, in the case of price-inelastic demand, consumers will continue buying almost the same amount, making the excess burden of the tax smaller.
03

Maximizing Revenue

If the aim is to maximize the revenue from the tax, the government would again choose to tax goods with an inelastic demand. This is because consumers' demand for these goods does not decrease significantly when the price increases due to the tax. The revenue from the tax is the tax per unit times the number of units sold, so it will be larger when more units are sold as the case with inelastic demand.
04

Taxation to Discourage Consumption

If the government intends to discourage smoking or drinking alcohol, a tax would be more effective if the demand for these goods is price elastic. With elastic demand, consumers are more responsive to price changes. Thus, an increase in price due to a tax will lead more consumers to decrease their consumption of these goods.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Excess Burden
The concept of the excess burden of taxation refers to the economic losses that society incurs beyond the actual revenue collected by taxes. This happens because taxes change prices and thus affect the behavior of consumers and producers. Imagine excess burden as the hidden cost of taxation, which impacts overall economic efficiency.

When the government imposes taxes, it can lead to reduced consumption or production, which distorts how resources are utilized in the market. This distortion is what we refer to as the excess burden.
  • If a good has inelastic demand (consumers buy about the same amount even if the price goes up), imposing a tax on such goods leads to smaller changes in consumption and therefore, a smaller excess burden.
  • Conversely, taxing goods with elastic demand (large change in quantity purchased when prices fluctuate) leads to bigger changes in behavior and a larger excess burden.
Choosing which goods to tax based on their elasticity helps in minimizing these economic losses.
Price Elasticity of Demand
Price elasticity of demand is a key concept in economics that measures how much the quantity demanded of a good changes in response to a change in price. It determines how consumers will react when the government imposes a new tax.
  • An elastic demand means a small price change will lead to a significant change in quantity demanded. Consumers are more sensitive to price fluctuations.
  • An inelastic demand indicates that the quantity demanded doesn't change much with price changes, reflecting less sensitivity to price changes.
If a government wants to minimize economic disruption, understanding elasticity is crucial. For less impactful taxation, targeting goods with inelastic demand ensures minimal changes in consumer purchasing behavior, thus keeping the market stable.
Government Revenue
Government revenue from taxes is a crucial aspect of fiscal policy. It is generated primarily through taxes on goods and services. Knowing how to maximize this revenue without causing undue economic hardship is vital for governments.

To optimize revenue through excise taxes, it's advantageous to focus on products with inelastic demand. This is because:
  • The quantity sold remains relatively stable despite the price increase, ensuring a steady flow of revenue.
  • Consumers' continued purchase of taxed goods means higher net tax collections, even with minimal consumption adjustments.
Inelastic goods help sustain government programs while minimizing economic disruption.
Excise Taxes
Excise taxes are taxes imposed on specific goods, often aiming to achieve more than just revenue collection. Governments often use them to regulate consumption and generate funds for public projects.
  • These taxes can significantly impact goods with price elasticity, affecting how much people buy.
  • For inelastic goods, excise taxes can raise revenue without much affecting the amount sold because demand doesn’t change significantly.
  • In contrast, for goods with elastic demand, these taxes can be effective at curbing consumption, as higher prices discourage purchasing.
By understanding the elasticity of different goods, policymakers can strategically impose excise taxes to either maximize revenue or influence social behavior, such as reducing smoking or alcohol consumption.

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Most popular questions from this chapter

(Related to the Chapter Opener on page 600) In a column in the Washington Post, Robert J. Samuelson wrote, "As for what's caused greater inequality, we're also in the dark. The Reagan and Bush tax cuts are weak explanations, because gains have occurred in pretax incomes.... Up to a point, inequality is inevitable and desirable." a. What are pretax incomes? b. Do you agree with Samuelson's argument that income inequality may be inevitable and desirable? Briefly explain.

Many political observers have noted that Republican presidential candidates tend to emphasize their conservative positions on policy issues while running for their party's nomination, and Democratic presidential candidates tend to emphasize their liberal positions on policy issues while running for their party's nomination. In the general election, though, Republican candidates tend to downplay their conservative positions, and Democratic candidates tend to downplay their liberal positions. Can the median voter theorem help explain this pattern? Briefly explain.

(Related to the Apply the Concept on page 615 ) Business historian John Steele Gordon noted in a Wall Street Journal column that the first federal corporate income tax was enacted in 1909 , before passage of the Sixteenth Amendment made a federal income tax constitutional. According to Gordon, Congress enacted the corporate income tax because of "the political pressure to tax the rich." Is the corporate income tax an efficient means of taxing the rich? Briefly explain.

An article in a Federal Reserve publication noted that "nearly all taxes create some market inefficiency in the form of deadweight loss." The article further noted that when something is taxed, the result is "an outcome in which both [buyers and sellers] would gain from more production." a. Briefly explain why taxes result in deadweight loss. b. If buyers and sellers would gain from more production of a good or service that is taxed, why doesn't more of the good or service get produced?"

According to an article in the New York Times, when the French government imposed a new tax on sales of beer, t estimated that the retail price of beer would rise by he equivalent of 6 cents per half pint. A spokesman for he beer industry argued that the actual increase in price would be 25 cents per half pint. Discuss the differences between the French government's and the beer industry's estimates of the price elasticity of demand for beer.

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