BR6C: Bridge: Taxes
Question 1
The government places excise (per unit) taxes on a variety of goods consumers buy, including gasoline, cigarettes, and alcoholic beverages. How would you describe the demand elasticity of goods most likely to be subject to excise taxes?
A. They tend to be perfectly elastic.
B. They tend to be inelastic.
C. They tend to be elastic.
D. They tend to be unitary elastic.
Hint
Demand elasticity is the responsiveness of quantity demanded to changes in price.Answer
B. They tend to be inelastic. Tax incidence depends on the relative elasticity of demand and supply. If demand is less elastic than supply, then buyers are less able than sellers to avoid the tax and so bear most of the tax burden. If supply is less elastic than demand, then sellers have less ability to avoid the tax and so bear the larger share of the burden. Excise taxes are typically imposed on items with inelastic demand—often, on addictive substances, such as cigarettes and alcoholic beverages, or necessities, like gasoline. That way, such taxes may curb an undesirable behavior while raising substantial revenues from consumers.Question 2
Which of the following will occur when a new tax is placed on satellite radio services?
A. The price consumers pay will rise by less than the amount of the tax.
B. The quantity of satellite radio services will rise to make up for the tax.
C. Consumers will end up with the entire burden of the new tax.
D. The profits of satellite radio companies will rise.
Hint
A tax is typically paid by both buyers and sellers, with the incidence of the tax determined by relative elasticities of supply and demand.Answer
A. The price consumers pay will rise by less than the amount of the tax. The satellite radio services will raise their price, so that consumers pay some portion of the tax. However, unless demand is perfectly inelastic, the price will rise by less than the amount of tax. Tax incidence depends on the relative elasticities of demand and supply.Question 3
When cigarette taxes are raised, what is a potential social benefit that may result?
A. The total amount of taxes collected will fall.
B. The quantity of cigarettes purchased will fall, as some consumers will stop smoking.
C. Companies will develop healthier cigarettes.
D. The price that consumers pay will fall because demand is elastic.
Hint
Cigarettes generate a negative externality, since bystanders inhale users' second-hand smoke.Answer
B. The quantity of cigarettes purchased will fall, as some consumers will stop smoking. Consumers who are not addicted to cigarettes may consider cutting back or quitting when cigarette taxes are raised. This benefits society, since second-hand smoke will be reduced.Question 4
If a city places a \$10 tax on every skateboard sold, who ends up with the burden of the tax?
A. Neither consumers nor shops will face any burden of the tax.
B. Skateboard consumers will pay all of the tax because stores will pass the tax onto customers.
C. Skateboard consumers and shops will likely share the burden of the tax.
D. Skateboard shops will pay all of the tax because it does not want to lose any customers.
Hint
Tax incidence depends on the relative elasticites of supply and demand.Answer
C. Skateboard consumers and shops will likely share the burden of the tax. The least elastic side of the market is the side least able to avoid a tax and so bears the larger burden of a tax. For one side to bear the full burden of a tax, however, it would have to be perfectly inelastic—i.e., it would have to exhibit no response to changes in price. Since neither the demand for nor the supply of skateboards seems likely to be perfectly inelastic, skateboard consumers and shops will likely share the burden of the tax.Question 5
Suppose that owners refill their pet’s prescription every month. If the government eliminates all taxes on pet medications, who will benefit more?
A. Pet owners would receive most of the tax savings.
B. Pet owners and drug companies would share the tax savings equally.
C. Drug companies would receive most of the tax savings.
D. Neither pet owners nor drug companies would see any tax savings.