Price Elasticity and Taxation

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PriceElasticity and Taxation

Elasticityof demand describes the change in quantity of goods demanded thatresults from an increase in price for the goods. It shows thepercentage change in goods demanded as a result of a percentage inchange of price. This paper will discuss price elasticity andinelasticity and explain how both determine who bears the economicburden of government taxes.

Theprice is elastic if the price elastic of demand is greater than one,meaning a percentage change in price caused more than a percentagechange in units demanded. Therefore there is a great effect on thedemand when the price has changed. This happens mainly in luxurygoods or those not necessarily needed for survival. Marketers willmaximize their revenues when they set the price so that elasticity ofdemand is 1.

Inelasticityof demand is where consumers buy same quantity of goods whether theprices change or not. The change in units demanded is very small ornone. This happens in products that people love or are a survivalnecessity like medicine and cannot be over used. Whether the priceincreases or decreases, the number of units demanded will remainrelatively the same. It means if the price changes by a percentage,the change in demand will be less than a percentage.

Inelasticityhelps a manufacturer determine what price to set their goods at. Ifseller knows decreasing price will lead to a heightened demand,thereby raising their revenues, then they will employ this strategy.When increase in price results to low sales and thus less revenue,then the price will be set at optimal level, to ensure it does notlead to reduction in quantities sold.

Taxcollected by governments depends of the price elasticity, which alsodetermines who bears the burden of tax. In the scenario where priceis inelastic, the seller can decide to push the tax burden to theconsumer. For example, if selling a vehicle that costs the company100USD in tax, and the seller knows an increase in the price of thevehicle by same amount does not affect the number of units sold, thenthey can decide to increase the price by that amount. This means thefull cost of tax will be borne by the buyer and not the seller.

Whenthe seller cannot raise prices because of the elasticity of demand,then they have to bear the burden of tax. In the above example, ifthe seller knows raising the cost of the vehicle will reduce unitssold and therefore reduce revenues, they may know raise the price,but will have to bear the burden of government tax. This mostly willresult in push back to others in the line of production likesuppliers, employees, and others in the chain, in an effort torecover this cost by the seller. If they can however raise the priceby half that amount that is by 50USD they will do this, and thusshare the tax burden with the buyer.

Inconclusion, when there is elasticity of demand, the economic burdenof tax will be borne by the seller. Where the elasticity of demand isinelastic, the economic burden of tax will be borne by the buyer.Where the price elasticity of demand is equal to the price elasticityof supply, then the tax burden will be shared equally between thebuyer and seller. The two concepts are therefore important forbusinesses as they use them to optimize on their revenues and sharethe tax cost with the sellers.