Question

Deadweight losses arising from an excise tax are greatest when demand:

A. and supply are relatively elastic

B. is relatively inelastic and supply is relatively elastic

C. and supply are relatively inelastic.

D. is relatively elastic and supply is relatively inelastic.

Answer 1

Since less the elasticity of demand, less will be the dead weight loss because consumer are less reluctant to leave the market due to an increase in the price.

So more the elastic the demand curve, more will be the dead weight loss and vice-versa.

Similarly when supply is inelastic, it is difficult to leave the market for the seller, when tax is increased, so deadweight loss will be smaller in case of inelastic supply and vice-versa.

Hence it can be said that Deadweight losses arising from an excise tax are greatest when demand and supply are relatively elastic.

Hence option A is the correct answer.