Government is advised to tax goods whose demand curves are inelastic if the good is to raise tax revenues. If the goal is to discourage consumption, then it ought to tax goods whose demand curves are elastic. Explain the statements.
Inelastic goods are those whose demand does not change due to the fact that there are no substitutes (e.g. gasoline). So if you raise prices on inelastic demand curve items, such as by adding more taxes, this will result in more revenue due to the fact that there are no sustitutes for this product. And this is what is exactly happening with respect to gasoline as the oil companies are making phenominal profits these days even as the cost of gasoline keeeps going up and up. People just don't have a choice here. If there was a substuitute for gasoline (ethanol?) you can be sure this would not be happening. Elastic goods on the other hand are those goods for which there are substitutes for; accordingly, if you raise prices (e.g. adding taxes) people are going to look elsewhere and this will discourage consumption for that particular good. (e.g. if you raise the price of beef people can eat more chicken instead). As another example of this, hundreds of thousands of people are leaving AOL due to the fact they now realize they can get a better buy for their buck elsewhere as there are much more substitutes for getting online at a better cost. |
