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Applications of the price elasticity of demand

1) Why do you think that whenever the government wants to increase their revenue they usually decide to increase the tax on items such as gas, tobacco products and/or alcohol?

2) Why is it unlikely that a firm would sell at a price where its demand curve happens to be price inelastic?

3) Assume the demand for cosmetic or plastic surgery is price inelastic. Are the following statements true or false? Explain.

a. when the price of plastic surgery increases, the number of operations decreases.
b. the percentage change in the price of plastic surgery is less than the percentage change in quantity demanded.
c. changes in the price of plastic surgery do not effect the number of operations
d. quantity demanded is quite responsive to changes in price
e. if more plastic surgery is performed, expenditures on plastic surgery will decrease.
f. the marginal revenue of another operation is negative.

Solution Preview

1) Why do you think that whenever the government wants to increase their revenue they usually decide to increase the tax on items such as gas, tobacco products and/or alcohol?

Items like gas, tobacco products and alcohol have inelastic demand. Increasing the tax leads to an increase in price of the good. In case of inelastic demand, percent drop in quantity demanded will be less than percent increase in price and total revenue will increases. So, total tax revenue will also increase. We can see that government can increase its tax revenues without distorting the consumption for the inelastic cases.

2) Why is it ...

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