Demand Elasticity

Discussion on the excerpt from Microeconomics by Jeffrey Perloff, based on “Senate Panel Kills Tax on Luxury Items” (Los Angeles Times, 1992), “The Bottom Line” (New York, 1992), and “Taxes: Tempestin a Yacht Basin” (Time, 1991).

The concept of demand elasticity is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. Demand elasticity is of extreme importance to the firm, as it helps the firm model potential changes in quantity demanded due to changes in price, therefore optimizing competitive behavior. In Jeffrey Perloff’s article, “Tax Revenues from Federal Luxury Taxes,” the government thought it would be beneficial to tax luxury items in order to raise tax revenues by imposing a tax on the wealthy without affecting the poor. The goal was to minimize harm on the poor, while increasing revenue through taxes on the wealthy. However, a failure to incorporate demand elasticity caused unexpected results.

A 10% tax imposed on luxury items such as yachts, planes, cars, furs, and jewelry costing over a certain amount of money caused differing changes in revenues. The article highlights the differing elasticity between cars and yachts; cars are inelastic, while the yacht market is very elastic. This tax failed to address all possible side effects that are present in markets, specifically demand elasticity.

Due to the miscalculation of the effects of demand elasticity, the yachting industry demonstrates the harm of this tax to domestic producers. Congressional analyst didn’t take into consideration the tax avoiding behavior of consumers, the tendency to not purchase a product if the price increases. This had the unforeseen consequences of costing around 45,000 people their jobs in only one year in the yachting industry alone.

As Perloff clearly states, the information about elasticities of demand and supply are integral when making Congressional decisions that affect tax laws in order to address these unintended effects.

The demand for luxury goods is elastic, increases in price causes steep decreases in quantity demanded. In these cases, producers are forced to bear the burden of a tax, which explains the effects on employment. In Perloff’s article, the decision to tax luxury goods is not consistent with the objective of the tax. The tax was originated to tax the wealthy not the poor, but because the demand for luxury goods is elastic, the producers absorbed the burden. The article specifically mentions the yacht industry. In the first year of the yacht tax, sales of yachts costing over $100,000 dropped by 71%. As a repercussion of this, a drop in sales caused thousands of people to lose their jobs. As a result of this job loss, the government actually lost money from the loss of payroll taxes. Therefore, this tax does not affect the wealthy as much as it impacts the poor. Poor and middle class citizens generally would hold production jobs at the yacht factories, and the tax was the main proponent of them losing their main source of livelihood.

The economic idea of demand elasticity can be seen in the real world in many different examples.  The textbook market is just one accurate example of the influence of demand elasticity on a market. In today’s world, students will always need to purchase textbooks for their classes. New versions are always coming out of specific textbooks, and classes generally require the purchase of a textbook. This creates an inelastic market. If a tax were to be imposed on new textbooks, the students will absorb the effects of the tax. Since there will always be a need for required books and updated versions this will raise tax revenues at the expense of the consumers. Overall, demand elasticity can be applied to almost every economic situation regarding prices. It is important for analysts and anyone using these measures to take demand elasticity into effect before making any major decisions that could have unforeseen consequences.

Posted by Molly, Ben and Sydney (Section 2)

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