Please help me with the following problem: It is frequently asserted that taxes
ID: 1130680 • Letter: P
Question
Please help me with the following problem:
It is frequently asserted that taxes on cigarettes and beer are regressive, because the poor individuals spend a larger fraction of their income on such items than do better-off individuals. How would your estimate of the degree of regressivity be affected if you thought these commodities were produced by
(i) competitive industries with perfectly elastic supply schedules;
(ii) a monopoly with a linear demand schedule;
(iIi) a monopoly facing constant elasticity of demand schedule? Provide a justification.
Explanation / Answer
Traditionally it’s thought that taxes on cigarettes and beer are regressive, because the poor individuals spend a larger fraction of their income on such items than do better-off individuals. Regressive taxation lowers the burden of people with high ability to pay & transfers to those with less income.
1) A product has perfectly elastic supply if its price change creates a significant change in quantity supplied. In this case the elasticity of supply range is from 0 to infinity.
So now we will evaluate how taxes impact on tobacco products & Beer. Consumer are the one who ultimately pay the taxes. If these products were produced by competitive industries with perfectly elastic supply schedules there will be significant change in prices. In a competitive industry with perfectly supply schedules, Sellers will be able to supply any quantity above a certain price & no seller will be willing to supply below a certain price. Therefore price of these commodities remains constant. If supply is perfectly elastic the price rises by full amount of tax, which means the consumers have to pay entire amount of tax. Therefore consumers with less income will have to pay larger amount of tax on these products with respect to high income consumers.