how is elasticity related to the revenue from a sales tax? a. If demand is inela
ID: 1191111 • Letter: H
Question
how is elasticity related to the revenue from a sales tax?
a. If demand is inelastic, then raising tax rates will decrease tax revenue paid by consumers. This principle works similarly with supply. With elastic supply and demand, increasing taxes will increase quantity supplied and quantity demanded enough to cause an increase in tax revenue. Thus, what happens to total tax revenue depends both on the elasticity of supply and demand.
b. If demand is inelastic, then raising tax rates will decrease tax revenue paid by consumers. The elasticity of supply has no effect on taxes because taxes only matter to consumers (who have to pay the taxes). Thus, what happens to total tax revenue depends only on the elasticity of demand.
c. If demand is inelastic, then raising tax rates will increase tax revenue paid by consumers. The elasticity of supply has no effect on taxes because taxes only matter to consumers (who have to pay the taxes). Thus, what happens to total tax revenue depends only on the elasticity of demand.
d. If demand is inelastic, then raising tax rates will increase tax revenue paid by consumers. This principle works similarly with supply. With elastic supply and demand, increasing taxes will decrease quantity supplied and quantity demanded enough to cause a decrease in tax revenue. Thus, what happens to total tax revenue depends both on the elasticity of supply and demand.
Explanation / Answer
Correct option (d).
An increase in sales tax rate will raise the cost of production and the producers' will face higher cost of production. If demand is inelastic, producers can pass on the increase in cost to consumers in form of higher price, and tax revenue paid by consumers will increase.
But if supply curve is inelastic but demand is elastic, then most of the tax burden is borne by the producer.
The tax incidence (share of tax to be borne) depends on elasticity of demand and supply both.
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