Question

A. The government is exploring ways to increase revenues through taxation. Lisette is an economic adviser to public policy makers, and they pose to her the following question: Should the government tax yachts or should it tax gasoline? Explain your answer using price elasticity of demand.

B. Esther is a politician who promises cheaper gasoline for everyone in the country if she is elected. Once she is elected, she makes gas cheaper by imposing a price ceiling that is one full dollar less than the market’s equilibrium price. What would be the reaction of the sellers of gasoline and of the public to Esther’s price ceiling law? Would she expect to be reelected in the long run?

Answer 1

A. Government should tax gasoline. In order to raise revenue from taxes the government should tax necessities because they have inelastic demand. When tax raises their market price, fall in consumption due to higher price is relatively less in terms of percentage change so that tax revenue is greater. In case of luxuries such as yachts, when tax is imposed, elastic demand causes a greater percentage fall in sales so that less tax revenue is generated.

B. Sellers will find it difficult to supply what is demanded at the ceiling price. Public will demand more gasoline once its price is reduced. This implies that there will be a severe shortage of gasoline. No. In the long run she would not be reelected because in the long run people will realize that she is again going to put price ceiling in gasoline market and this information will now be available to them.