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Motivation: Sales taxes are imposed for various objectives. Governments may want to simply gap the state budget deficit or reallocate the resources to the benefit of the whole society. One question of interest (to the producers and the consumers of the taxed good at least) is who pays the tax. The tax laws provide one answer: The statutory incidence of a tax indicates who is legally responsible for the tax payment. The statutory incidence does not, however, tell the whole (or even the most interesting part of the) story of who pays the tax. To determine who really pays the tax, we must investigate its economic incidence. Also, the tax would naturally affect the other related market as well - both price and sales/consumption. The following questions deal with the above issue. Try to grasp the thorough economics behind the following story and questions Questions: Among the tax proposals regularly considered by Congress is an additional tax on distilled liquors. Suppose that the tax applies only to liquors but not to beer. The price elasticity of supply of liquor is 4.0, and the price elasticity of demand for liquor is (-0.2. The cross-elasticity of demand for beer with respect to the price of liquor is 0.1. (1) If the new sales tax (or GST or VAT) is imposed on liquor, who will bear the greater burden - liquor suppliers or liquor consumers? Why? (Hint: Recall what you learned on how economic tax incidence between buyers and sellers can be determined by the price elasticities of demand and supply.) (2) As a result of the tax, would the drinkers in the market spend more on liquors than before the tax or less? (Hint: Note and realize that we can answer this question even without the detailed information on demand or supply curves, i.e., without calculating the actual spending on liquors by drinkers. Please recall the revenue implication of the price elasticity you learned from the asynchronous session: the S-revenue for the sellers is not different from the S-spending by the buyers.) (3) Suppose that the market price of liquor increased by 30% after the tax. Assuming that beer supply is infinitely elastic, how will the new tax affect the beer price and consumption? Please quantify your answer. (Hint: No need to provide a graph in your answer but you can try to draw demand and supply curve for beer to get an idea how the liquor price increase would affect the demand curve for beer. The cross price elasticity of demand for beer with respect to the liquor price as quoted in the question will be a critical information.)

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