Question

a.What is the elasticity rule?

b.What is the broad base rule?

c.Consider two goods—food bought at the grocery store and restaurant meals. Food bought at the grocery store is more inelastic in demand. Restaurant meals are more elastic in demand.What does the Inverse Elasticity Rule say about how the government should tax each of these goods? What are the equity implications of the taxes suggested by this rule?

Answer 1

a. Elasticity indicates the relationship between Change in price and change in quantity demanded in a given period of time. If demand is price Elastic that means percentage change in quantity demanded is greater than percentage change in price. The opposite holds when demand is price inelastic.

The elasticity rule is that highly elastic goods are taxed at low rates, low elasticity goods at high rates.

B. Broad base rule states that it's better to tax wide variety of goods at moderate rates than a few high rates.