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Chapter 9: Problem 9

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-liquor 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
a) The liquor consumers will bear the greater burden of the new tax because the demand for liquor is less elastic than supply. b) With an infinitely elastic beer supply, the new tax will only increase the quantity of beer sold but have no effect on its price due to the increase in demand from liquor consumers.

Step by step solution

01

Identify the price elasticity of supply and demand

The price elasticity of supply for liquor is given as 4.0, which means the supply is elastic. The price elasticity of demand is given as -0.2, which means the demand is inelastic.
02

Determine who bears the greater burden

Based on the concept of elasticity, the one who bears the greatest burden of a tax is the one who is least able to respond to the tax by changing the quantity bought or sold. In this case, since the demand is less elastic than supply, liquor consumers will bear the greater burden of the tax.
03

Analyze the cross-elasticity of demand for beer

The cross-elasticity of demand for beer with respect to the price of liquor is given as 0.1. This positive value means that beer and liquor are substitute goods, so if the price of liquor rises due to the tax, the demand for beer will increase.
04

Determine the effect on the beer market

If the supply of beer is infinitely elastic, which means that suppliers are willing to sell as much beer as demanded at the current price, the increased demand for beer due to the tax on liquor will increase the quantity of beer sold but will not impact the price of beer.

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Most popular questions from this chapter

About 100 million pounds of jelly beans are consumed in the United States each year, and the price has been about 50 cents per pound. However, jelly bean producers feel that their incomes are too low and have convinced the government that price supports are in order. The government will therefore buy up as many jelly beans as necessary to keep the price at \(\$ 1\) per pound. However, government economists are worried about the impact of this program because they have no estimates of the elasticities of jelly bean demand or supply. a. Could this program cost the government more than \(\$ 50\) million per year? Under what conditions? Could it cost less than \(\$ 50\) million per year? Under what conditions? Illustrate with a diagram. b. Could this program cost consumers (in terms of lost consumer surplus) more than \(\$ 50\) million per year? Under what conditions? Could it cost consumers less than \(\$ 50\) million per year? Under what conditions? Again, use a diagram to illustrate.

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