Question

If the government wanted to raise tax revenue and shift most of the tax burden to the sellers, it would impose a tax on a good with a a. steep (inelastic) demand curve and a steep (inelastic) supply curve. b. steep (inelastic) demand curve and a flat (elastic) supply curve. c. flat (perfectly elastic) demand curve and a steep (inelastic) supply curve. d. flat (perfectly elastic) demand curve and a flat (elastic) supply curve.

Short answer

The government should impose a tax on a good with a steep (inelastic) demand curve and a flat (elastic) supply curve to raise tax revenue and shift most of the tax burden to the sellers. The correct answer is (b).

Step-by-step solution

Identify the tax burden

To shift most of the tax burden to the sellers, the government should impose a tax on a good with a demand curve where the buyers are not very sensitive to price changes (inelastic) and a supply curve where sellers are sensitive to price changes (elastic). This way, when the tax is imposed, the sellers will be more likely to absorb the tax and not pass it on to the consumers in the form of higher prices.

Raise tax revenue

To raise tax revenue, the government should target goods with inelastic demand and supply curves. This is because, when demand and supply are inelastic, the quantity traded in the market is not very sensitive to price changes. Therefore, when the government imposes a tax on such goods, the quantity traded will not decrease significantly, allowing the government to collect more tax revenue.

Find the best combination

Now, we need to find the combination that satisfies both conditions (shifting the tax burden to the sellers and raising tax revenue). a. steep (inelastic) demand curve and a steep (inelastic) supply curve: This combination would allow the government to raise tax revenue, but it would not shift the tax burden to the sellers as both demand and supply are inelastic. b. steep (inelastic) demand curve and a flat (elastic) supply curve: This combination meets both criteria, as the inelastic demand curve allows for increased tax revenue, and the elastic supply curve shifts the tax burden to the sellers. c. flat (perfectly elastic) demand curve and a steep (inelastic) supply curve: This combination does not meet either criterion, as the perfectly elastic demand curve would not allow for increased tax revenue and would shift the tax burden to the buyers. d. flat (perfectly elastic) demand curve and a flat (elastic) supply curve: This combination also does not meet either criterion, as the perfectly elastic demand curve would not allow for increased tax revenue and the elastic supply curve would not shift the tax burden to the sellers. After analyzing all combinations, the correct answer is: b. steep (inelastic) demand curve and a flat (elastic) supply curve.

Key concepts

Inelastic Demand

Inelastic demand refers to a situation where consumers are not very sensitive to changes in the price of a good. This means that even if the price increases or decreases, the quantity demanded by consumers remains relatively stable. Inelastic demand typically occurs with essential goods such as medication or basic utilities.

When demand is inelastic, it is represented by a steep demand curve. This indicates that consumers will continue to buy almost the same amount, regardless of price fluctuations. Therefore, if a tax were imposed on a good with inelastic demand, sellers could increase prices without significantly reducing sales volumes.

This property of inelastic demand is crucial for government tax strategies, as it allows for higher revenue collection without greatly affecting the quantity sold. Understanding inelastic demand helps to gauge how taxes will influence consumer behavior and overall market dynamics.

Elastic Supply

Elastic supply means that producers are quite responsive to changes in the price of a good. When supply is elastic, a small change in price leads to a large change in the quantity supplied. This is graphically represented as a flatter supply curve in the economic model.

Sellers with elastic supply react quickly to price changes. Thus, if a government imposes a tax on a product, producers may choose to absorb the tax themselves rather than passing it on to consumers, especially when the demand is inelastic. This capability to adjust makes elasticity an important concept in understanding who bears the direct burden of taxation.

Elastic supply can significantly affect who effectively pays the bulk of a new tax, often resulting in producers taking on more of the tax burden when the demand for the good is not price-sensitive.

Tax Revenue

Tax revenue is the income that governments generate through taxation. It's vital for funding public services, infrastructure, and other governmental functions. When planning taxes, governments aim to balance revenue generation with economic impact.

Goods with inelastic demand are excellent candidates for taxation since taxes on these goods tend to result in substantial tax revenue. This is because the quantity demanded remains relatively unchanged despite higher prices due to the tax, ensuring that sales and thus tax income stay stable.

By understanding the interaction between tax policy, demand elasticity, and tax revenue, policymakers can design more efficient taxation strategies. The goal is often to maximize revenue while minimizing market distortions.

Government Taxation Policy

Government taxation policy involves decisions regarding how taxes are imposed and collected. It considers a range of factors, including economic conditions and social equity, to achieve desired financial and socioeconomic outcomes.

Policymakers often target goods or services with specific elasticities in demand and supply to achieve goals like altering consumption habits or correcting market imbalances. For example, a tax on a good with inelastic demand and elastic supply can result in more revenue for the government and puts the majority of the tax burden on producers as opposed to consumers.

By carefully crafting taxation policies according to elasticity dynamics, governments can enhance public revenues without causing significant harm to the overall economy. It structures fiscal plans both for growth and for catering to public needs.