I still not clear about Application: The costs of taxation topic. There is solut
ID: 1134940 • Letter: I
Question
I still not clear about Application: The costs of taxation topic. There is solutions and question, I need the explanation of the theory each question why the answer that and I also need the explanation how to draw the graph like the answer. Need the understanding this.
3aWith very clastie supply and very inelastic demand, the burden of the tax on rubber bands will be borne largely by buyers. As Figure 8.4 shows, consumer surplus declines considerably, by area A B, but producer surplus doesn't fall much at all, just by area C+D. Figure 8.4 Supply Demand Quantity of Rubber Bands b With very inclastic supply and very clastic demand, the burden of the tax on rubber bands will be borne largely by sellers. As Figure 8.5 shows, consumer surplus doesn't decline much, just by area A+B, while producer surplus falls substantially, by area C+D. Compared to part (a), producers bear much more of the burden of the tax, and consumers bear much less Figure 8.5 Supply Demand Quantity of Rubber BandsExplanation / Answer
The basic concept in all these questions is based on the relationship between elasticity of demand and supply with tax incidence. The more inelastic is the demand or supply then that side will bear a greater burden of the tax.
3.a.
The burden of the taxes will fall on the buyers as the demand is less responsive to the change in price and is represented by a fall in the consumers surplus.
b. Similarly, if supply curve is highly inelastic then greater burden would be levied by the producer and less by the buyers. If price of the good rises as tax is applied on the good and producers donot react by reducing supply which is a case when supply curve is inelastic then it implies loss in producer surplus.
c.One of the determinants of elasticity is time period. Demand or supply will be more responsive in the long run compared to the short run. As price of a good increases, in the first period elasticity will be low as buyers would take time to switch to other products or react to the change in price whereas in the long run .i.e. fifth year, consumers would develop taste for the cheaper good and elasticity of demand would be elastic and dead weight loss would be greater in the fifth year as both buyers and consumers would respond to the change in taxes reducing their loss in surplus and increasing deadweight loss.
b. Reveue is higher in the first year as demand is inelastic so output will not change and price will increase due to taxes but in the fifth year, demand is elastic so output will fall along with higher price so demand being elastic total revenue will reduce as output has declined.
5. Tax on food whose demand is inelastic as it is a necessity good to survive implies tax revenue would be greater But food is essential for a livelihood of poor society and cannot be done away with so it should be restrained from taxes especially the essential food items.