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Elasticity, Production and Cost in the Firm

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Question 1

When a government wants to increase tax revenue, they will often increase the sales tax on gasoline. Using price elasticity of demand, explain why the tax would be placed on gasoline rather than, say, yachts. What might be the long run effect of raising the price of gas?

Question 2

The shape of the long-run cost curve is determined by economies and diseconomies of scale. Contrast this curve with the short-run cost curve as it relates to increasing and diminishing marginal returns to labor.

Question 3

(Determinants of Price Elasticity) Why is the price elasticity of demand for Coca-Cola greater than the price elasticity of demand for soft drinks generally?

Solution Preview

1. Gasoline is inelastic. People have cars and need to use gas. Very few people will stop using their cars because of an increase in gas. Thus, a sales tax, will not change the demand for gas significantly. If the tax was on yachts, which are luxury goods, people will probably react by decreasing their demand for yachts significantly. Given an increase in gas prices due to taxes, on the long run, consumers will seek to buy more energy efficient cars, decreasing the demand for gasoline.

2. In the long run there are no fixed costs. You can vary everything. So ...

Solution Summary

Answers the questions:

Question 1

When a government wants to increase tax revenue, they will often increase the sales tax on gasoline. Using price elasticity of demand, explain why the tax would be placed on gasoline rather than, say, yachts. What might be the long run effect of raising the price of gas?

Question 2

The shape of the long-run cost curve is determined by economies and diseconomies of scale. Contrast this curve with the short-run cost curve as it relates to increasing and diminishing marginal returns to labor.

Question 3

(Determinants of Price Elasticity) Why is the price elasticity of demand for Coca-Cola greater than the price elasticity of demand for soft drinks generally?

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