Question

In a transaction for a good valued at $550 by a buyer and $500 by a seller, what percentage sales tax (assume tax on $500) would result in an unconsummated transaction

Answer 1

A percentage sales tax that is more than 10% will result in an unconsummated transaction, because the buyer is not willing to pay more than $550 for the good.

Step-by-step explanation:

A sales tax of 10% will make the good to cost $550 ($500 x 1.1). This is the maximum value placed on the good by the buyer. If the rate of the sales tax exceeds this rate, the buyer will likely not buy the good unless it is an essential good that she cannot do without. So, in levying sales taxes, it is important to understand the demand elasticity of the good. A good whose demand is inelastic is more likely to favor high sales tax rates than a similar good with elastic demand. This elasticity of demand tries to explain the response that demand will generate based on an increase or a decrease in price of a good.