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The government of Washlovia wants to impose a tax on clothes dryers. In East Washlovia the...

The government of Washlovia wants to impose a tax on clothes dryers. In East Washlovia the demand elasticity for clothes dryers is -2.4 while in West Washlovia the demand elasticity is -1.7. Where will the tax inefficiency be greater? Explain.

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Answer #1

Absolute value of elasticity of demand in East Washlovia is higher than that in West Washlovia, so demand is more elastic in East Washlovia. When demand is elastic, a N% rise in price (caused by tax) will lead to a more than N% decrease in quantity demanded. The more elastic the demand, the higher than % fall in quantity for a given % increase in price. As a result, the more elastic the demand, the higher the deadweight loss from tax and the greater the tax inefficiency. So East Washlovia will have greater tax inefficiency.

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