question archive Donald is a tax analyst for the city of Econburgh, and has been asked to predict how much tax revenues will be generated if the city imposed a gasoline tax
Donald is a tax analyst for the city of Econburgh, and has been asked to predict how much tax revenues will be generated if the city imposed a gasoline tax
Subject:EconomicsPrice:2.88 Bought3
Donald is a tax analyst for the city of Econburgh, and has been asked to predict how much tax revenues will be generated if the city imposed a gasoline tax. Initially, 100 million gallons per day are bought in the city, and the price elasticity of demand is -4.0. The tax, which is $0.10/gallon, will increase the price of gasoline by 5%.
a. With the tax, predict how many gallons of gasoline will be bought in the city.
b How much tax revenues will be generated?
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a. Given:
- Elasticity of demand = - 4
- Percentage increase in price = 5%
Elasticity of demand (e) = Percentage change in quantity demanded / Percentage change in price
- 4 = Percentage change in quantity demanded / 5%
Percentage change in quantity demanded = -20%
Hence, a tax of $0.10 / gallon will decrease the quantity demanded by 20%
Initial Quantity demanded (Q0) = 100
Percentage change in quantity = (Q1 - Q0) / Q0 * 100
-20 = (Q1 - 100) / 100 * 100
Q1 = 80 units
Hence, the current quantity demanded after the imposition of taxes is equal to 80 units.
b. Tax Revenue = Tax rate * Q1
Tax Revenue = 0.10 * 80 = $8
Hence, the government will earn a tax revenue of $8.
