Question

The supply of aged cheddar cheese is inelastic, and the supply of bread is elastic. Both goods are considered to be normal goods by a majority of consumers. Suppose that a large income tax increase decreases the demand for both goods by 10%.The equilibrium quantity will:The answer is decrease in both the aged cheddar cheese and bread markets. Why?

Answer 1

Aged Cheddar cheese & Bread prices fall because their has been a decrease in their demand.

Step-by-step explanation:

Given : Aged Cheddar cheese & Bread having inelastic & elastic supply respectively ; Income tax increase decreases demand of both.

Income Tax is a direct tax whose incidence an impact lie on the same person & burden can't be shifted.

• Increase in income Tax reduces the disposable income of consumers & as said - reduces demand of both the goods.
• This tax burden can't be shared between sellers & buyers will not effect the supply side (unlike indirect tax - eg sales tax).

Elasticities of supply is just supply responsiveness to price change, is not relevant here.

So : Supply being same & decrease in demand (i.e leftwards shift in demand curve) creates Excess Supply at that price level, irrespective of supply elasticity. Excess supply creates competition among sellers and reduces the price.