If the absolute value of the tax elasticity of supply is 2.0,a tax increase of 10 percent will decrease output by
A)20 percent and increase tax revenues.
B)20 percent and decrease tax revenues.
C)5 percent and increase tax revenues.

Question

Quizplus · Accepted Answer

The tax elasticity of supply measures the percentage change in quantity supplied in response to a one percent change in the tax rate. A tax elasticity of supply of 2.0 means that a 10 percent increase in the tax rate will lead to a 20 percent decrease in quantity supplied (2.0 x 10 percent).

Since output decreases by 20 percent, choice A is incorrect.

If the tax increase leads to a decrease in output, tax revenues may decrease as well if the decrease in output exceeds the increase in the tax rate. In this case, the increase in the tax rate is 10 percent, but the decrease in output is 20 percent. Therefore, it is likely that tax revenues will decrease as well, making choice B the correct answer.

Choice C is incorrect because a 10 percent tax increase will not lead to a 5 percent decrease in output if the tax elasticity of supply is 2.0.

If the Absolute Value of the Tax Elasticity of Supply