In: Economics
Tax cuts is a part of expansionary fiscal policy. This move incentivizes customers and sellers. Customers spend more as good/service becomes cheaper. However, it should be noted that when demand is inelastic, customer bears the burden and when supply is inelastic then seller bears the burden. In this case, eating out is not a necessity and has elastic demand and hence sellers can affect the demand by changing prices.
1) As a restaurant manager, how would you decide on how much you are going to cut the prices and which items’ prices to cut?
As discussed earlier, the eatables having high elasticity would be price cut and inelastic like alcohol will be charged the same. It can also be an effective strategy to decrease alcohol prices to lure the customers and charge prices on food items. Alcohol has inelastic demand as shown in fig. d, Price paid by customers earlier was P* and quantity was Q *, but tax put raises price to Pc and Quantity changes to Qt. But it is seen in the diagram that price change is large but Quantity change is small. Hence, hotels may charge high on alcohols. Govt. stands a chance to collect more revenue. As demand for food is increasing more jobs will be generated.
Food items are having elastic demand as shown in fig. C. for a small change in price(In case of tax cuts, price goes down from Pc to P* and quantity changes highly from Qt to Q*). This shows high revenue for hotel owners and also govt. stands a chance to collect revenue.
Example- It can be any normal food dish which people prefer.
2) What kind of restaurants would cut their prices deep and what kind of restaurants are not likely to pass any benefit to consumers?
Premium luxury restaurants may not decrease its food and service prices as premium pricing is also a strategy to differentiation. Lower and middle budget restaurants will cut prices to attract day to day customers and increase sales revenue. People also prefer low budget hotels to eat out. As shown in fig.a, many small hotels have inelastic supply and they cannot change immediately as they have to rely on customers response daily. Tax reduction will bring prices down from Pc to P* and they will change supply from Qt to Q*, which makes customers to buy more and as hotel owners do not have to pay tax and hence they also receive price higher from Pp to P* . (Fig. b)Premium hotels will have a small effect of tax cuts as they have premium customers and tax reductions will increase their sales but their budgets are still out of middle income customers.