Multiple Choice
A tax imposed on consumers of a good:
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6. Introduction to Taxes and Subsidies
Elasticity and Taxes
Multiple Choice
If the price elasticity of demand for gasoline is inelastic, how will a gasoline tax affect total consumer spending?
A
Total consumer spending on gasoline will increase, because the percentage fall in quantity demanded is smaller than the percentage rise in price.
B
Total consumer spending on gasoline will remain about the same, because the tax only shifts money from consumers to the government without changing expenditure.
C
The effect on total consumer spending is ambiguous and depends on whether producers or consumers bear most of the tax burden.
D
Total consumer spending on gasoline will decrease, because the tax reduces quantity demanded enough to lower overall spending.
Verified step by step guidance1
Step 1: Understand the concept of price elasticity of demand, which measures how much the quantity demanded of a good responds to a change in its price. If demand is inelastic, the absolute value of the price elasticity is less than 1, meaning quantity demanded changes proportionally less than the price change.
Step 2: Recognize that when a tax is imposed on gasoline, it effectively increases the price consumers pay. This price increase tends to reduce the quantity demanded, but the extent of this reduction depends on the elasticity.
Step 3: Since demand for gasoline is inelastic, the percentage decrease in quantity demanded will be smaller than the percentage increase in price caused by the tax.
Step 4: Total consumer spending is calculated as price multiplied by quantity demanded. Because the price rises and quantity falls by a smaller percentage, the overall product (total spending) will increase.
Step 5: Conclude that with inelastic demand, a tax on gasoline leads to higher total consumer spending on gasoline, as consumers reduce quantity only slightly while paying a higher price.
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