Question

The effect of a tax on soda would:

reduce production of soda

create deadweight loss

reduce consumption of soda

all of the above

Answer 1

Since the elasticity of demand can be defined as the measurement of the degree of the responsiveness of the quantity demand due to the change in the price level.

Price elasticity of demand= % change in the quantity demand/ % change in the price

If Ed is greater than 1, then the demand is elastic.

If Ed is less than 1, then the demand is elastic.

Incidence of tax means how much proportion of tax falls on buyers or on sellers and it depends on the relative elasticity of demand and supply.

Irrespective of on whom tax is imposed, tax burden will be shared by both sellers and buyers.

The burden of tax falls more on the inelastic side, so if demand is relatively inelastic, then burden of tax falls more on buyers while burden of tax will be less on the sellers and vice-versa.

It means when a tax has been imposed on the soda, then tax will be shared by both sellers and buyers, so price for buyers increase and for seller it decrease.

Hence production of soda will decrease and consumption of soda also decrease.

Since equilibrium quantity of soda decreases, so there will be deadweight loss.

It means all three options are correct.

Hence option all of the above are correct.

Hence option fourth is the correct answer.