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.
An item with an elastic demand is one in which a certain change in price will cause a larger change in its demand (Baumol, & Blinder, 2015). Conversely, an item with an inelastic demand is one in which a certain change in price will cause a smaller percentage change in its demand. When the government wants to increase tax revenue, it is best for them to put it on gasoline rather than yachts because gasoline has a more inelastic demand. The price change on gasoline due to tax increase does not affect the demand too heavily. Moreover, consumers’ demand for gasoline is more than that of yachts.
The government will generate a larger total revenue due to increased prices for gasoline. On the other hand, the consumers will be worse-off. From the scenario, the government will benefit while the consumers are harmed. Low-income households are disproportionately harmed as compared to the high-income households. Consumers with less disposable income are harmed most while the higher income families will not feel much effect of raised gasoline prices because they have a higher disposable income. People will still demand gasoline unless they decide to buy hybrid cars to substitute the gas.
Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.
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