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Tax-Induced Price Increase and Elasticity

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Type of Elasticity Estimate

Relatively elastic (E>1)
Airline Travel, long run 2.4
Fresh Fish 2.2
New cars, short run 1.2 - 1.5

Unitary elastic (E=1)
Private Education 1.1
Radios and televisions 1.2
Shoes 0.9

Relatively inelastic (E<1)
Cigarettes 0.4
Coffee 0.3
Gasoline, short run 0.2
Long-distance telephone calls 0.1

Questions
A) How large of a tax-induced price increase would it take to reduce cigarette consumption by 20 percent? Show work.
B) Identify three goods each for which your demand is (a) elastic and (b) inelastic. What accounts for the difference of elasticity? Explain thoroughly.

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Solution Summary

There are two problems. Solution to first problem describes the steps to calculate the tax induced price change necessary to bring down the consumption of cigarette by a certain percent value. Solution to second problem discusses the factors responsible for difference in elasticity.

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1. How large of a tax-induced price increase would it take to reduce cigarette consumption by 20 percent? Show work.

Percent change in consumption (quantity demanded)=20%
Price elasticity of demand for cigarette=-0.40
Price elasticity of demand=Percent change in quantity demanded/Percent change in price

So, Percent change in price=Percent change in quantity demanded/Price elasticity of demand
=20%/0.4=50%
Increase in tax should be enough to increase the price by 50%

2. Identify three goods each for which your demand is (a) elastic and (b) inelastic. What accounts for the difference of elasticity? Explain thoroughly.

Examples of inelastic goods : Salt, insulin, Gasoline in the ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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