Importance Of Price Elasticity Of Demand In Taxation

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Importance of Price and Income Elasticities of Demand on Taxation policy.

Tax is the compulsory amount each individual pays to the state depending on their income in the case of income tax. While Value added Tax (VAT) is the tax on most goods and service; these sorts of taxes raise the price of goods and services to which they apply. A taxation policy is when the government chooses which taxes to impose, in what amounts, and on whom. This is where price and income elasticies of Demand need to be taken into account. Price elasticity of demand shows how responsive or elastic the quantity demanded of a good or service is to a change in its price, ceteris paribus while income elasticites shows how responsive or elastic the quantity demanded
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There are different types of demand depending on how much percentage change there is in demand when the price s changed. When the demand does not change at all when the price changes, the price elasticity of demand is zero which means the demand is perfectly inelastic. When the price elasticity of demand is between 0 and 1 it means the percentage change in demand is smaller than the percentage change in price, then demand is inelastic. When yhe price elasticity of demand is exactly 1, the percentage change in demand is exactly the same as the percentage change in price then demand is said to be unit elastic. When the price elasticity of demand is greater than 1, then there is a substantial change in percentage of demand when the price changes; the demand is elastic. In some cases, the consumer doesn’t have a choice but to purchase a particular product e.g. insulin to a diabetic customer. Regardless of changes in price (you can’t opt for cheaper insulin) they would have to buy it which makes it a good with perfect inelastic demand. However, when demand for the product is perfectly elastic e.g. Digestive biscuits - The consumers would not purchase as they have a variety to choose from and would instead go for a cheaper alternative. So if the government increases the sales tax on digestive biscuits( or any …show more content…
Rather than observing elastic and inelastic prices, the type of product is taken into account; if it is an inferior or a normal good/service. Normal goods or services are those where when you earn more- you buy more. For example you take the bus until you earn enough money to buy a car which makes a car a normal good; and in turn taking the bus is the inferior good as the more you earn, the less you use the good/service. Normal goods have a positive income elasticity of demand of between 0 and 1. Inferior Goods on the other hand have a negative income elasticity of demand. The government is more likely to tax higher on normal goods than inferior goods to maintain

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