Question

The city is considering raising revenues by imposing a sales tax on one of two products, beer or red bull. Assume that the supply of red bull is very inelastic, and that the supply of beer is highly (not perfectly) elastic. Assume also the the demand for both

beer and red bull is perfectly elastic and that the market clearing price for beer and red bull with no sales tax is $1.00. Further assume that without any tax, the current amount of beer and red bull sold is 100 gallons each.

Answer 1

To optimize tax revenue with minimal disruption, the city should tax Red Bull over beer due to its inelastic supply, resulting in less reduction in quantity sold and higher revenue given the perfectly elastic demand.

Step-by-step explanation:

The question revolves around utilizing price elasticity principles to decide whether a city should impose a sales tax on beer or Red Bull. Given that the supply of Red Bull is very inelastic, and the supply of beer is highly elastic, alongside a perfectly elastic demand for both, we can determine the tax implications. To maximize tax revenue and minimize market disruption, the city should tax the product with the more inelastic supply, in this case, Red Bull.

This is because tax incidence and tax burden fall primarily on the side of the market that is less elastic. Therefore, the government is likely to raise more revenue by taxing Red Bull due to its inelastic supply, resulting in a lesser quantity reduction as compared to beer with an elastic supply. Moreover, the formula tax revenue = tax rate x quantity sold suggests that taxing a good with an inelastic supply will yield greater tax revenue without significant volume changes.