Question

Your friend posts an article which states "...Economists estimate that the elasticity of supply of coffee is twice the size (in absolute value) as the elasticity of demand for coffee. Our proposal to tax coffee suppliers $0.1 per cup of coffee sold will discourage these companies from raising prices and exploiting their consumers."

Evaluate the economic merits of this argument using concepts from this course. Recall that the buyer's burden of a tax is ϵ S ϵ S − ϵ D.

Answer 1

Ans. The price elasticity of supply means the percentage decrease in supply due to 1% decrease in price level and price elasticity of demand means the percentage decrease in demand due to 1% increase in price level.

A tax on coffee will decrease the price recieved by the sellers leading to a decrease in supply. This decrease in supply of coffee in the market will increase its price in the market. This increase in price will decrease the demand for coffee in the market which might have brought back to initial level if tge decrease in demand was equal to demand in supply but as price elasticity of supply is twice that of demand's, so, decrease in demand is less than the decrease in supply, increasing the price of the coffee in the market. So, a tax on coffee increases the price of coffee, so, buyers are worse off. This can be seen using the formula for tax burden on buyer, suppose absolut elasticity of demand is x, so, elasticity of supply is 2x ( and price elasticity of demand is negative)

Burden on buyer = 2x / (2x - (-x)) = 0.6666 or 66.66%
So, maximum percentage of tax is paid by the buyers in the form of increased price of coffee making them worse off.

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