Question

City Microeconomics has fallen into a huge budget deficit due to an increase in city spending. The city council has decided to increase sales tax for only one of the following two goods, Good A or Good B. The council reaches out to you, knowing that you are an expert in midpoint formula and elasticity, to decide which good to tax in order to maximize their tax revenue. They present the following sample of sales data (not total sales data) for your analysis. Which good would you recommend to the council to levy a tax on and why? Explain in detail using elasticity

Answer 1

The good that has the lower elasticity should be taxed. This is because when the elasticity is low, the rate of decrease in demand is lower than the rate of increase in prices. Thus, the total revenue = price*quantiity will increase.

Using the mid-point formula the elasticity can be claculated as follows:

Elasticity = [(Q2 - Q1)/((Q2 + Q1)/2)]/[(P2 - P1)/((P2 + P1)/2)]

Thus, through this formula the elasticity for both the goods can be calculated the one with lower value (in absolute terms) should be taxed.