Among the tax proposals regularly considered by Congress is an additional tax on distilled liquors. The would not apply to beer. The own-price elasticity of supply of liquor is 4.0 and the own-price elasticity of demand is -0.2. The cross price elasticity of demand for beer with respect to the price of liquor is 0.1. a. If the new tax is imposed, who will bear the greater burden, liquor suppliers or consumers? Explain. b. How will the new tax affect the beer market?

The fraction of tax borne by the consumers depends upon the elasticity of demand and supply. Here, the elasticity of supply (Es) of liquor is 4.0 and, the elasticity of demand (Ed) of liquor is -0.2. So, the fraction of tax borne by the consumer will be:

[Math Processing Error]=EsEs−Ed×100=44−(−0.2)×100=95%

b) How will the new tax affect the beer market.

Explanation:

Demand for beer and the price of liquor have positive cross-elasticity that is 0.1. It implies a decrease in the price of liquor will decrease the demand for the beer, and vice-versa. Tax increases the price of liquor due to which people will reduce their demand for liquor and attracts towards the beer, and that, in turn, increases the quantity demanded of beer.