a.

Price elasticity of demand (Ep) measures the degree of responsiveness of the quantity

demanded of a commodity to changes in its price. (T.C. Lee, 2011). There are basically 5 types of Ep mainly, perfectly inelastic demand, inelastic demand, unit elastic demand, elastic demand and perfectly elastic demand. The more elastic the demand of a good, the lesser tax the consumers have to pay. This will then lead to a reduction of total revenue for the government. For instance, if government were to place a tax on demand elastic luxury goods such as perfumes, producers will increase the price of perfumes and this will cause the quantity demanded of perfumes to reduce because more consumers are willing to substitute perfumes with something else or not live with perfumes at all. With more buyers leaving the market which causes the size of the market to reduce, consumption of perfumes will reduce. This in return will reduce the total collection of the governments revenue. Therefore, the government should not place a tax on demand elastic luxury goods such as perfumes as this will only be pointless as it reduces the collection of revenue for the government.

b.
Price ($)

SS

P2 P0

A B D F

C E DD

P2

Quantity (units) Q1 Q0

Market for perfumes when tax is imposed (demand is elastic)

Without Tax Consumer surplus Producer surplus Tax revenue Total surplus A+B+C D+E+F None A+B++C+D+E+F

With Tax A F B+D A+B+D+F

Change -(B+C) -(D+E) B+D -(C+E)

Price ($) SS A P1 B C P0 P2 F DD Q1 Q0 Quantity (units) D E

Market for perfumes when tax is imposed (demand is inelastic)

Without tax Consumer surplus Producer surplus Tax revenue Total surplus A+B+C D+E+F None A+B++C+D+E+F

With Tax A F B+D A+B+D+F

Change -(B+C) -(D+E) B+D -(C+E)

As seen above in the diagrams, when demand for perfume is inelastic, more has to be paid by the consumers than compared with when the demand for perfume is elastic. This happens because when the demand of a good is elastic, more of the tax imposed burden will fall on the consumers. Therefore, the consumer surplus for the market where the demand for perfumes is elastic is higher than the market where the demand for perfumes is inelastic. This could be because if perfumes are demand inelastic, even if the price of perfumes increases, consumers will still purchase the same quantity of perfumes and thus not changing their consumption by much. This is the same case for producers surplus also whereby the producer surplus in the market where demand is elastic for perfumes is lower than that of the market where demand for perfumes is inelastic. In total, after tax, consumer surplus and producer surplus will both be lower than before the tax was imposed. Other than that, the burden of tax will usually fall on the side which is more inelastic. In this case, most of the burden of the tax will fall on demand side where it is more inelastic because when the demand is inelastic, consumers will not respond much to tax and therefore, will pay more tax. This in turn will increase the revenue for the government. Lastly, the impact on overall social welfare is that deadweight loss is sure to occur. When a tax is imposed, the fall in surplus resulted is called deadweight loss. Changes in total welfare are equivalent to the change in consumer surplus + change in producers surplus + changes in total surplus. With tax, both buyers and sellers will be made worse off than they are before the tax is imposed and this is because both the prices will be higher than before the tax was imposed.