Question

1. New Jersey wants to impose a tax on economics textbooks. In New Brunswick the demand elasticity for textbooks is −4.1 while in Newark the demand elasticity is −1.2. If both areas demanded the same quantity of textbooks before the tax, on which campus will the tax generate more deadweight loss? Why? Illustrate your answer.

Answer 1

In New Brunswick the demand elasticity for textbooks is −4.1. In contrast, Newark the demand elasticity is −1.2. Both cases have an elastic demand but relative to Newark, the demand is elastic in New Brunswick. If both areas demanded the same quantity of textbooks before the tax, we can expect that a tax that is of the same size and that is imposed in both the markets, will be generating greater revenue in Newark because of its relatively inelastic demand. However, New Brunswick is likely to generate more deadweight loss because when tax is imposed in the market with elastic demand, reduction in quantity is greater in percentage terms than increase in prices so that size of deadweight loss is greater. This is shown in the diagram below.

Newark New Brunswick Price Price Si P1 P1 P2 P2 D1 D1 D2 \D2 Q1 Q0 Quantity Quantity Q1