The local government decides to impose a sales tax on some selected items. On item X the final prices increases almost the full amount of the tax, demand does not change much and the tax revenues collected are quite high. On item Y the price increases very little but demand falls quite a bit and very little tax revenue is collected. Is this a violation of the law of demand or something else? Explain.

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Business

Greta Nelson

4 May, 13:26

The local government decides to impose a sales tax on some selected items. On item X the final prices increases almost the full amount of the tax, demand does not change much and the tax revenues collected are quite high. On item Y the price increases very little but demand falls quite a bit and very little tax revenue is collected. Is this a violation of the law of demand or something else? Explain.

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Jaime Conrad · Answer 1

It isn't a violation of the law of demand. It is as a result of the elasticity of demand.

A tax is a compulsory sum levied on a good or service. Taxes increases the price of products. In determining whom should bear the greater burden of the tax between the consumer and the seller, elasticities are usually considered. The party with either a relatively inelastic supply or demand bears the greater burden of tax while the party with the more elastic demand or supply bears less burden of tax.

Demand (supply) is elastic if a small change in price has a greater effect on the quantity demanded (supplied).

Demand (supply) is inelastic if a small change in price has little or no effect on the quantity demanded (supplied).

For good X, consumers have an inelastic demand so they bear more of the tax Burden. As a result of the tax, price increases, yet the quantity demanded doesn't change. Therefore, the total revenue would rise.

For good Y, consumers have an elastic demand. Therefore, they bear less burden of tax. As a result of the increase in price, the quantity demanded falls and total revenue falls.