Taxes are a useful basis for government revenue as the goods that are taxed usually have

highly inelastic demand curves. Discuss this statement.

Economists found that economics is a dynamic process. Given the millions of human
interactions that make up an economy, it is not surprising that things do not stay the same for
very long, if at all. An understanding of demand and supply gives the fundamentals of how
markets operate the determination of prices and output in the product market for example.
However, responses of output to a change in the price of the good are not uniform across
goods. For government to provide goods and services such as national defense, social
security, national parks, excetra, it must have money. The government must raise revenues
equal to the cost of providing the amount of goods and services that its citizens demand. The
Government raises money in several ways including user fees and taxes. Taxes may be paid
by everyone or only those that use a good or service therefore, who pays depends on the type
of tax. There are a number of taxes which include Personal Income taxes, Corporate Income
taxes, Exercise Taxes, Value Added Taxes (VAT), Property Taxes, Social Security Taxes, and
Sales Taxes. This paper will ascertain the reasons, influences, factors and determinants why
taxes are a useful basis for Government revenue as the goods that are taxed usually have
highly inelastic demand curves.
Government tax revenue does not necessarily increase as the tax rate increases. The
government will earn more tax income at 1% rate than at 0%, but they will not earn more at
100% than they will at 10%, due to the disincentives high tax rates cause. Thus there is a
peak tax rate where government revenue is highest. The relationship between income tax
rates and government revenue can be graphed on something called a Laffer Curve.
Inelastic Demand

Demand is price inelastic, if the value of elasticity is less than one. If the demand for a good
is inelastic then a percentage change in the price will bring about a smaller percentage change
in the quantity demanded. For example, in Zimbabwe if a 10% increase in price by a rail
company results in a 1% fall in train journeys made, then price elasticity would be -1%
divided by 10% = - 0.1 and the demand for rail journeys is therefore inelastic.

In the diagram above there has been a 100% increase in the price which has led to a 25%
decrease in the quantity demanded. The value of Price Elastic Demand (PED) is therefore
-25 divided by 100= -0.25. If the value of PED is between 0 and 1 then the price elasticity of
demand is inelastic. This means that a percentage change in the price will lead to a smaller
percentage change in the quantity demanded.
Inelastic Demand Curves is when the demand for an item changes proportionately less than
the price changes, then the item price are inelastic and highly unresponsive to changes in
some endogenous factor. For example, a demand curve is inelastic if the price of an item
increases by 1 percent and purchases decrease by half a percent. Demand curves for items
that people need to survive, such as staple foods, are inelastic, because people will buy the
items regardless of price. Inelastic goods are often described as necessities. A shift in price
does not drastically impact consumer demand or the overall supply of the good because it is
not something people are able or willing to go without, for examples inelastic goods would be
water, housing, food and many more.
Government usually tax goods that have a highly inelastic because they are never short
changed due to its necessity to the market. These goods are needs that people cannot do
without them and government will never run out of revenue, services such as water. However,
Elastic Demand Curves is when the demand for an item changes proportionately more than
the price changes, then the item is price elastic. For example, if a 1 percent price increase
leads to a decrease in demand of 2 percent, then the item has an elastic demand. These items
usually have many substitutes or are luxury items for example coffee, airline tickets and
stocks.

Since the government tax goods that have highly inelastic demand there are factors that make
demand inelastic, such as no substitutes. For example, in Zimbabwe if a person have a car,
there is no alternative but, to buy petrol to fill up the car. If people rely on the train to get to
work, the train firm can increase prices with little fall in demand. Another factor is little
competition; if a firm has monopoly power then it is able to charge higher prices. For
example, prices on motorway service stations tend to be higher, because consumers cannot
choose where to buy food, without leaving the motorway. If goods are bought infrequently
such as salt, you are less likely to be sensitive to price.
Taxes reduce both demand and supply, and drive market equilibrium to a price that is higher
than without the tax and a quantity that is lower than without the tax. Government tax
authorities usually require either the buyer or the seller to be legally responsible for payment
of the tax. Taxes will typically constitute a greater burden for whichever party has a more
inelastic curve, for example if supply is inelastic and demand is elastic, the burden will be
greater on the producers. Suppose that Zimbabwe Government imposes a tax upon milk
producers (Dairiboad Zimbabwe) of $1 per gallon as shown on the diagram below.

The figure above shows original price for milk was $2 per gallon. After imposition of the tax,
the supply curves shift up and to the left. Consumers pay $2.60 per gallon. Sellers receive
$1.60 per gallon after paying the tax. So sixty cents of the tax is actually paid by consumers,
while forty cents is paid by the milk producers. The triangle ABC above represents the
deadweight loss due to taxation, which occurs because now there are fewer mutually

beneficial exchanges between buyers and sellers. Deadweight loss stems from foregone
economic activity and is a loss that does not lead to an offsetting gain for other market
participants; it is a permanent decrease to consumer and/or producer surplus.
However, although taxes are a useful basis for the Government revenue as the goods that are
taxed usually have highly inelastic demands curves, price elasticity of demand is mainly of
interest to the government for the purposes of taxation. Government in most places impose
sales taxes or value-added taxes. These sorts of taxes raise the price of goods and services to
which they apply. Government need to know the price elasticity of demand for these goods
and services so they can know the likely impact of the tax. For example, if the demand for
hotel rooms at Holiday inn is very inelastic, then the government can increase the sales tax on
hotel rooms without creating a situation where the hotel lose business and tax revenues fall.
Government will not want to raise sales taxes on items that are very elastic.
Price elasticity of demand is thus important to the government because it directly impacts the
tax regime of the economy. The government has a responsibility to balance or moderate the
tax burden between consumers and producers. This is done to ensure that consumers have
access to certain essential products and the producers maintain their ability to provide
products and services and ensure profitability. For example, when a government increases
taxes on a product exhibiting perfect inelastic demand the burden of the tax falls on the
consumers because they have no option but to purchase. However, when the taxes are
imposed on products exhibiting perfect elastic demand then the tax burden falls on the
producers since they cannot pass it on to the consumers. Therefore, government need to know
about price elasticity of demand.
How slopes of demand and supply curves influenced by elasticity? Elasticity Supply and
Demand Curves have two important points to consider which that elasticity is related but, is
not the same as slope and elasticity changes along straight-line demand and supply curves.
Elasticity is not the same as slope.The relationship between elasticity and slope means that
the steeper the curve begins at a given point, the less elastic is supply or demand. There are
two limiting examples of this. When the curves are flat, we call the curves perfectly elastic.
Perfectly elastic curves are flat curves in which quantity changes enormously in response to a
proportional change in price. When the curves are vertical, we call the curves perfectly
inelastic. Perfectly inelastic curves are vertical curves in which quantity does not change at

all in response to an enormous proportional change in price. Elasticity changes along

Straight-Line Curves. Elasticity changes along the straight line supply and demand curves
whereas slope does not. On a demand curve, elasticity is perfectly elastic at the price
intercept. It becomes smaller as you move down the demand curve until it becomes zero at
the quantity intercept. Elasticity is perfectly elastic where a straight line supply curve
intercepts the price axis. Points become less elastic as you move out along the supply curve.
The price elasticity of supply is equal to the reciprocal of the slope of the supply curve times
the ratio of price to quantity supplied. In this case, however, there is no complication
regarding arithmetic sign, since both the slope of the supply curve and the price elasticity of
supply are greater than or equal to zero. Other elasticities, such as the income elasticity of
demand, do not have straightforward relationships with the slopes of the supply and demand
curves.
Furthermore, there are factors that determine the elasticity of demand and why government
chose to levy tax. Typically, goods that are thought of as necessities will be very inelastic.
That is, no matter how expensive they get, consumers will still buy them. Health care, staple
foods and petrol are goods with low elasticities. If a demand curve is perfectly vertical (up
and down) then we say it is perfectly inelastic. If the curve is not steep, but instead shallow,
then the good is said to be elastic or highly elastic. This means that a small change in the
price of the good will have a large change in the quantity demanded. If the curve is perfectly
flat (horizontal), then we say that it is perfectly elastic. Luxury goods are often very elastic if
the price increases a little, then people will move over to an alternative.
Elasticity of demand is an economics concept that relates to the relative change in quantity
demanded that is associated with a price change for a product. A product has high elasticity
when a price change causes a relatively significant change in demand. An inelastic product
shows less demand changes from a price change. Several factors affect the elasticity of a
given product.
Type of Product
Products that customers consider essentials or necessities tend to have less elasticity than
products viewed as luxury or discretionary. If a customer believes he needs a certain product
for survival, quality of life, or pleasure, he is more likely to stretch a bit to purchase the item

if the price goes up. On the contrary, a product viewed as optional is a less likely purchase as
the price increases because the customer believes he can live without it.
Customer Options
The more options a customer has to meet a particular functional or emotional need, the more
elastic a product's demand. This is why a company with a monopoly has a huge advantage.
Customers do not have options and feel compelled to buy from the given provider. In highly
competitive industries, price differentials are usually less among competing brands because
of the ability customers have to select lower-priced alternatives. A closely related factor is the
cost of switching brands. Cell phone customers often wait to change providers to avoid
penalties if they are obligated to service contracts.
Budget Impact
The effect of a change in price has on the customer's budget also affects elasticity. A price
change that would more severely affect a buyer's budget will lead to greater demand
elasticity. A customer is more likely to stretch from $1 to $1.50 to get a snack or drink he
prefers than he is to stretch from $200 a month to $300 a month on a car payment. Thus,
lower-end products and services, especially those viewed as essential, typically allow more
room for pricing adjustments.
Brand Value
From a company's perspective, effective advertising can also impact the elasticity of demand.
Advertising is used over time to build up the customer's perception of worth of a given brand.
For example when Econet was building its network brand it stretch its price more than other
brand's in the same industry without as much of a reputation. High-end designer fashion
brands are usually more inelastic, for instance, because buyers have strong preferences and
are often willing to pay whatever is asked to get what they want.
Alternative use
The demand for those goods having more than one use is said to be elastic. In other words
goods having alternative uses are elastic. All the uses are not of same importance. As the
commodities are put to certain less urgent needs or uses as a result of fall in price their
demand raises. People use those commodities for certain urgent use in response to a rise in

price. For example electricity can be used for a number of purposes like heating, lighting,
cooking, cooling etc. If the electricity bill increases people utilise electricity for certain
important urgent purpose and if the bill falls people use electricity for a number of other
unimportant uses. Thus the demand for electricity is elastic.
Durability of Commodities
The demand for durable commodities is elastic whereas the demand for less durable
commodity is inelastic. Durable commodity is used over a long period of time. The utility of
a durable good is destroyed continuously. Once a durable good is bought the buyer feels no
want of it for a long period of time. Thus the change (rise or fall) in price cannot influence the
demand. Thus the demand becomes elastic. On the other hand less durable or perishable
goods are consumed repeatedly. Any change in price affects the demand. Thus the demand for
perishable goods is less elastic.
Income level:
Elasticity of demand depends on income level. The rich and the poor are not equally affected
at the change in price. Poor people are more affected than the rich. Because of high income
rich people buy the same amount of an expensive commodity in response to a rise in price.
For example with a rise in price of fresh milk, poor people buy other milk powder relatively
cheaper than fresh. Thus for rich people the demand for fresh milk is inelastic whereas for
poor people the demand for the fresh milk is elastic.
Taxes are levied by government at the time of sale for some goods. The effect of the tax
causes the consumer to pay a higher price for the good than the price the producer receives
for the same good, the difference in the price paid and the price received is the amount of the
tax.
Subsequently, it is critical for a Government choosing to levy against goods that display
lowest degree of price elasticity of demand in order to fix on international trade. In order to
fix prices of the goods to be exported, it is important government to have knowledge about
the elasticitys of demand for such goods. A country may fix higher prices for the products
with inelastic demand. However, if demand for such goods in the importing country is elastic,
then the exporting country will have to fix lower prices.

Formulation of Government Policies

The concept of price elasticity of demand is important for formulating government policies,
especially the taxation policy. Government can impose higher taxes on goods with inelastic
demand, whereas, low rates of taxes are imposed on commodities with elastic demand.
Factor Pricing
Price elasticity of demand helps government in determining price to be paid to the factors of
production. Share of each factor in the national product is determined in proportion to its
demand in the productive activity. If demand for a particular factor is inelastic as compared to
the other factors, then it will attract more rewards.
Decisions of Monopolist
A monopolist considers the nature of demand while fixing price of his product. If demand for
the product is elastic, then it will fix low price. However, if demand is inelastic, then he is in
a position to fix a high price.
Paradox of poverty amidst plenty
A bumper crop, instead of bringing prosperity to farmers, brings poverty. This is called the
paradox of poverty amidst plenty. It happens due to inelastic demand for most of the
agricultural products for example tobacco in Zimbabwe. When supply of tobacco increases,
as a result of rich harvest, their prices drastically fall due to inelastic demand. As a result,
their total income goes down.
In conclusion a demand curve is a functional relationship. It is a curve that defines the
relationship behind how much of a good will be demanded in a market at a certain price.
Change the price, and a different quantity will be demanded. Demand is not a constant, but a
variable. Demand curves slope downwards because of the notion of declining marginal
utility, the more of something that one has consumed, the less benefit and, therefore, the less
they are willing to pay for the next unit of the good in question. Also, this is why the price
elasticity of demand is negative: if price goes up, quantity demanded goes down and vice
versa.

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