State the Inverse Elasticity Rule and explain it using some graphs to show how a change...

State the Inverse Elasticity Rule and explain it using some graphs to show how a change in the price elasticity of supply impacts the size of the excess burden of a tax.

Expert Solution

We know that the inverse elasticity rule explains that the Ramsey result in an elasticity form. The rule is “the tax rates on goods inversely related to their elasticity of demand”. It is used to explain the tax policy to elasticity of demand. The incidence of tax ultimately relates to elasticity of supply and demand that is the percentage changes in prices and elasticity of supply and demand. Also the dead weight loss regarding taxation is expressed by elasticity of demand and supply.

Here Ramsey explains the impact of taxation by using price elasticity of supply using perfectly elastic supply. That is supplier will provide an infinite amount by given price. Here the more inelastic in demand the less the dead weight loss. Graphically,

In the first diagram shows perfectly elastic supply. Here the dead weight loss is higher because elastic demand. And also the revenue earned by tax is lower. In the second diagram the more the elasticity of demand the dead weight loss is lesser.

Rahul Sunny answered 2 years ago

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