If the government wants to minimize the welfare loss of a tax, it should tax goods with more inelastic demands or supplies.

Question

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When a tax is imposed on a market, it causes a reduction in consumer surplus and producer surplus, resulting in a welfare loss. The size of this welfare loss depends on the elasticities of demand and supply in the market. When a good has an inelastic demand or supply, it means that buyers or sellers are not very responsive to changes in price. Therefore, when a tax is imposed on such a good, the change in quantity demanded or supplied is relatively small, resulting in a smaller welfare loss. On the other hand, when a good has an elastic demand or supply, buyers or sellers are very responsive to changes in price, and a tax on such a good would result in a larger welfare loss. Therefore, if the government wants to minimize the welfare loss of a tax, it should tax goods with more inelastic demands or supplies.

If the Government Wants to Minimize the Welfare Loss of a Tax