1. A government is proposing to increase the tax on petrol. Examine the relevance of price elasticity of demand for this proposal.
When considering increase the tax on petrol, there are a few things to look at. First of all, the price elasticity of demand is a measure of responsiveness of the quantity of a good or service demanded to change in its price. Petrol is an inelastic product. This is because petrol is a needed in a daily basis. An increase in price of petrol will cause a small change (decrease) in petrol. Therefore it is inelastic as its quantity demanded has a small responsive to the price.
Figure 1.1 illustrates the demand and supply for petrol. When the tax increases, the supply curve will shift to the left. Price will increase from P2 to P1. However, consumers are more burdened than producers. This can be seen in figure 1.1. As the area (a) and (b) is the government’s tax revenue, area (a) is consumer’s burden and area (b) is producer’s burden. When a certain good is inelastic (in this case, petrol) the consumer will have to pay more than the producer.
Moreover, looking at the price elasticity of supply, the burden of the tax might differ according to the elasticity of its supply and demand. Below is a graphs that will show how the tax may differ.
Figure 1.2 shows ane lastic demand and supply curve. Here we can see that the tax revenue (a+b) are equal. This means that if both demand and supply are elastic, the burden of consumers (a) and producer (b) are the same. When comparing figure 1.1 and figure 1.2, tax differs depending on the elasticity of its demand and supply.
When considering income elasticity of demand for increasing the tax of petrol, we must firstly know what it is. Income elasticity of demand is a measure of how much the demand of a product changes when there is...
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