Tax Cuts in India

Answer the following questions to check your understanding of the story.

What is the price elasticity of demand for life-saving drugs?

a) Very low—demand is highly inelastic.

b) Very low at low prices and very high at high prices.

c) Very high—demand is highly elastic.

d) Unit elastic—expenditure on them is the same at every price.

Wrong! - Is the demand for life-saving drugs the same regardless of their affordability? What happens to the price elasticity of demand when the drugs become unaffordable?

Correct! - For essential life-saving drugs, the quantity demanded remains constant regardless of price and demand is perfectly inelastic as long as the price is below buyers’ maximum willingness to pay. When these drugs become unaffordable, demand becomes perfectly elastic.

If equilibrium in the market for life-saving drugs occurs at a price where demand is perfectly inelastic, how does the market change when the government makes drugs tax free?

a) The tax saving is shared equally by buyers and sellers, the equilibrium price falls and the equilibrium quantity increases.

b) The tax saving is shared equally by buyers and sellers, the equilibrium price rises and the equilibrium quantity increases.

c) Buyers save the entire tax, and the price received by sellers and the quantity bought and sold do not change.

d) Sellers save the entire tax, and the price paid by buyers and the quantity bought and sold do not change.

Wrong! - When the demand for life-saving drugs is perfectly inelastic, do sellers bear the entire tax? Do sellers and buyers equally bear the entire tax burden?

Well Done! - When the demand for life-saving drugs is perfectly inelastic, buyers bear the entire tax burden. When the tax is removed, buyers save the entire tax, so the price received by sellers and the quantity traded do not change.

How does the tax incidence change in the market for TVs when the GST is lowered?

a) Buyers and sellers both pay less tax.

b) The decrease in the tax is split equally between buyers and sellers.

c) Buyers pay less tax and sellers pay no tax.

d) Sellers pay less tax and buyers pay no tax.

Wrong! - The demand for and the supply of TVs are neither perfectly inelastic nor perfectly elastic so the tax burden is split between buyers and sellers. When the GST is lowered, who pays less tax?

That's Right! - The demand for and the supply of TVs are neither perfectly inelastic nor perfectly elastic so the tax burden is split between buyers and sellers. When the GST is lowered both buyers and sellers pay less tax.

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