How does price elasticity of demand affect taxation?
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You are a chairperson of a state tax commission responsible for establishing a program to raise new revenue through exercise taxes. Why would elasticity of demand be important to you in determining the products on which the taxes should be levied?
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Solution Summary
The following demonstrates how the elasticity of demand affects the state excise taxes. The response outlines how whether demand is elastic or inelastic can have a large impact on the market being taxed as well as the tax revenue generated.
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Elasticity is a measure of how responsive quantity demanded is to price changes. When policy makers levy taxes they are raising price. If demand is very elastic (luxury goods for example) then the price increase will cause quantity demanded to decrease by a lot. which ultimately means less in tax ...
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