Question

1. Suppose that the government needs to raise money to pay for road construction and repair, school supplies, police, etc. It is trying to decide whether it should tax grocery purchases or meals at expensive restaurants. What would you recommend and why? Make sure to refer to concepts studied in chapter 8.
2. As you read in the lecture, economists disagree about the supply elasticity of labor. In your experience, do people respond to changing pay by working more (or less), or do they work about the same hours, no matter the pay?

Answer 1

When the government is required to impose tax on goods and services for financing its activities, it should consider the elasticity of demand for those goods and services. This is important because in case the elasticity of demand for a particular good is greater than 1 it is not fruitful to impose a tax because the equilibrium price will increase and when demand is elastic, an increase in price decreases the revenue. We are given that the government is considering taxing on grocery purchases or meals at expensive restaurants. On one side, meals at expensive restaurants exhibit an elastic demand because they are luxury. Grocery purchases are inelastic because consumers' response is feeble towards price changes. In this manner the government should tax grocer purchase in order to raise revenue because for an inelastic demand, when the equilibrium price is increased there will be an increase in the revenue as well.

Workers definitely respond to increased income by working for more number of hours to a large extent because the substitution effect dominates the income effect. The backward bending supply curve however suggest that for a very high level of income, further increases in income level only reduces the work effort. In this manner we can suggest that a great portion of the supply curve, increased pay will encourage work effort.