Among the tax proposals regularly considered by Congress is...

Among the tax proposals regularly considered by Congress is an additional tax on distilled liquors. The tax would not apply to beer. The price elasticity of supply of liquor is $4.0,$ and the price elasticity of demand is $-0.2 .$ The cross-elasticity of demand for beer with respect to the price of liquor is 0.1 a. If the new tax is imposed, who will bear the greater burden-liquor suppliers or liquor consumers? Why? b. Assuming that beer supply is infinitely elastic, how will the new tax affect the beer market?

Transcript

00:01 So here we're given a whole bunch of elasticity, right? we're told that the elasticity of supply for liquor is four.

00:06 That means the percentage change in the quantity of liquor supplied over the percentage change in the price of liquor is equal to four.

00:14 We know that the price elasticity of demand for liquor is minus 2, which point 2, which means the percentage change in the quantity of liquor demanded over the percentage change in the price of liquor.

00:25 And we know the cross elasticity of demand for beer with respect to the point.

00:30 The price of liquor is one.

00:31 So this is the elasticity between the quantity demanded of beer and the change in the price of liquor.

00:42 So a, we want to think about new tax on liquor.

00:51 Who bears the burden? who pays? the idea here is that the least elastic pays.

01:03 Most.

01:05 This is the basic principle of optimal taxation.

01:09 Because think about intuitively, if you are very elastic, right, very elastic, you go somewhere else, right? if you're very elastic, you switch and you don't pay, right? elasticity says, i have tons of options.

01:30 I'm happy to go drink some other beverage.

01:33 So i'm not going to pay.

01:35 But if you're inelastic, right, what happens is that you're stuck in the marketplace and you have to pay the tax.

01:47 So if i was going to try to illustrate this, what happens in this market is, oh, sorry, quantity goes on the bottom axis, quantity and price.

01:58 The supply curve here is very elastic.

02:01 But the demand curve is, is more inelastic.

02:05 We're now going to tax the supply...

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