Q9. Among the tax proposals regularl... [FREE SOLUTION]

Chapter 9: Q9. (page 364)

Among the tax proposals regularly considered by Congress is an additional tax on distilled liquors. The tax would not apply to beer. The price elasticity of supply of liquor is 4.0, and the price elasticity of demand is -0.2. The cross-elasticity of demand for beer with respect to the price of liquor is 0.1.
a. If the new tax is imposed, who will bear the greater burden鈥攍iquor suppliers or liquor consumers? Why?
b. Assuming that beer supply is infinitely elastic, how will the new tax affect the beer market?

Short Answer

Expert verified

Liquor consumers will bear the greater burden of additional tax.
The beer suppliers will bear the whole tax burden of the new tax.

Step by step solution

Step 1. Elasticity and burden of a tax

The elasticity of demand shows the percentage change in the quantity demanded by the percentage change in price. If the value of price elasticity of demand is less than 1, consumers bear a greater share of the tax burden. If the price elasticity of demand value is more than 1, producers bear a greater share of the tax burden.

The value of price elasticity of demand is -0.2, which is less than the value of 1. It shows that consumers' extent of change in demand is less than the extent of price change. The demand is showing less change to the change in price because of price. Therefore, the liquor consumers will bear the greater burden of additional tax.

Step 2. Effect of inelastic supply on the beer market

Since the supply of beer is inelastic, producers are not willing to change the supply of quantity to any extent with the price change. The price will increase due to tax but producers will not lower their quantity of beer supplied.

Hence, producers will bear the whole tax burden.