Textbook Problem

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Taxes on particular goods discourage their consumption. Economists say that such taxes “distort consumer demands.” In terms of the elasticity of demand or elasticity of supply for the commodities in question, what sort of goods would you choose to tax to achieve the following objectives?

1. Collect a large amount of tax revenue
2. Distort demand as little as possible
3. Discourage consumption of harmful commodities
4. Discourage production of polluting commodities

To determine

(a)

Type of good to tax that collects a large amount of tax revenue.

Explanation of Solution

When the quantity demanded of a good change very little due to fluctuation in its price, then the good is said to be inelastic.

Necessity goods due to their importance in survival have inelastic demand. For example, demand for prescribed drugs by a doctor to a patient would not decline, even if the price of such medicines increases a lot...

To determine

(b)

Type of good to tax that distorts demand as little as possible.

To determine

(c)

Type of good to tax that discourages the consumption of harmful commodities.

To determine

(d)

Type of good to tax that discourages the production of polluting commodities.