Question

A policymaker that wants to raise tax revenue while minimizing the deadweight loss should tax goods with inelastic supply and demand rather than goods with elastic supply and demand?

1) True
2) False

Answer 1

Yes, taxing goods with inelastic supply and demand helps a policymaker to raise revenue with minimal deadweight loss; the tax incidence leads to consumers or producers bearing the burden depending on the relative elasticity.

Step-by-step explanation:

A policymaker looking to raise tax revenue while minimizing the deadweight loss should indeed focus on goods with inelastic demand and supply. The tax incidence on such goods will most likely lead to a less than proportionate decrease in the quantity traded, thus maintaining tax revenues while causing minimal distortion in the market. In cases where demand is more inelastic than supply, consumers will bear the majority of the tax burden, and conversely, when supply is more inelastic than demand, producers will bear most of the burden. Due to the minimized reaction to price changes, deadweight loss associated with taxation is kept at bay, thus optimally meeting the policy objective.