Question

Assume that you work for a state agency and you are charged with generating additional sales tax revenue. You have obtained the own-price elasticities of demand for the following goods:

Coffee -0.25
Restaurant meals -2.60
Fresh green peas -2.80

a. If you had to impose a tax on only one of these three goods, which would you choose (and why) in order to maximize tax revenue?

b. Would the tax incidence tend to fall more on the consumer or the producer for this good (relative to taxes on the other two goods)?

Answer 1

A. I will prefer to impose tax on Coffee(-0.25) because it's Price Elasticity of demand is less than Restaurant meals (-2.60) and Fresh Green Peas(-2.80). Lesser price elasticity indicates that when tax imposition will raise the price of the product the demand will not fall to much. This will directly increase the tax revenue. On the other side tax imposed on highly demand elastic products will make consumer shift it's demand to other substitute. So the tax revenue will remain constant.

B. Here if tax is imposed on Coffee then tax incidence will fall on buyer. Because if price elasticity of demand is more than price elastic of supply then tax incidence falls on buyer and when price elasticity of demand is less than price elasticity of supply then tax incidence or tax burden falls on seller.

Assumption : Here, since price elasticity of coffee is less than 1 it is assumed that price elasticity of demand is less than price elasticity of supply.