Assume tomato has relatively inelastic demand. Explain why a sales tax on tomato is NOT an effective way of raising tax revenue?
A sales tax on tomatoes would not be an effective way of raising tax revenue primarily due to the relatively inelastic demand for tomatoes. When the demand for a product is inelastic, it means that consumers are not very responsive to changes in price. In other words, even if the price of tomatoes increases due to the sales tax, consumers would still continue to purchase tomatoes at a similar quantity.
As a result of the inelastic demand, the sales tax would not significantly reduce the quantity of tomatoes demanded and, therefore, would not generate substantial tax revenue. Consumers may find the increase in price relatively small and necessary for their tomato consumption, so their buying behavior would not drastically change.
Moreover, due to the relatively inelastic demand, the burden of the sales tax would likely fall mostly on the consumers rather than the producers. With inelastic demand, producers have the advantage of being able to pass on the increased costs to consumers without facing a significant loss in demand. This means that consumers would bear the majority of the tax burden, resulting in potential negative effects on their purchasing power.
To effectively raise tax revenue, it is generally more efficient to impose taxes on goods with relatively elastic demand. Elastic demand means that consumers are more responsive to changes in price, so any increase in price caused by the tax would lead to a more significant decline in the quantity demanded. This decrease in demand would result in a larger reduction in consumer welfare and higher tax revenue for the government.
Therefore, an effective way of raising tax revenue would involve imposing taxes on goods with elastic demand, as these taxes would lead to a greater decrease in quantity demanded and consequently generate more tax revenue.