Elasticity and tax incidence

• This activity is based on a "time for telling." (see link below in resources). The pedagogical premise is that students need to be aware of the economic problem to be studied before direct instruction about the relevant concept. Such reflection is best accomplished in an active experience such as an application exercise. At this point are aware that there is a problem to be solved and that their prior knowledge is insufficient to provide a definitive answer.
• The second part of a "time for telling" underscores the importance of transfer. After a new concept is introduced it is important for students to practice with the concept in a variety of contexts, in this case with a more challenging application exercise.
• This activity is appropriate for an introductory economics course that includes the impact of taxes based on price elasticities in competitive market. Prior to the first part of the activity students should be familiar with the concept of elasticity. Prior to the second part of the activity students should be familiar with the impact of elasticity on tax incidence.
• The first activity requires only 5 - 10 minutes. The second activity requires 20 - 30 minutes. There is no lower or upper limit to the class size.

Overview

This activity first introduces students to the impact of a cost change, in this case a tax, on price. After direct instruction on the impact of price elasticity of supply and demand on a price change, a second activity requires students to use the concept of elasticity to evaluate a real world policy proposal to tax sugar content of soft drinks.

Expected Student Learning Outcomes

In this exercise students will first identify their prior conception about the impact of a tax on price. Then, after direct instruction, students will be able to use the concepts of price elasticity of demand and supply to analyze tax incidence in a real world policy context.

Information Given to Students

Activity 1

As your apartment lease ends the landlord calls to inform you that her property taxes for the apartment have increased by $500 for the year. Your roommate asks what will happen to your rent over the next year. Based on your study of economics you predict:

A) rent will increase by more than $500
B) rent will increase by more than $400 but less than $500
C) rent will increase by more than $300 but less than $400
D) rent will increase by more than $200 but less than
$300
E) rent will remain the same

Handout 1 (Microsoft Word 2007 (.docx) 12kB Feb11 18)

Activity 2

In an effort to prevent increased obesity, your state proposes a tax of 30% on soft drinks containing sugar. Assuming that this is a competitive market, use your understanding of elasticity and tax incidence to evaluate this tax policy. Is it:

A) an undesirable policy because soft drink prices will rise
B) a desirable policy because soft drink consumption will fall
C) an undesirable policy because there will be little impact on soft drink consumption
D) an undesirable policy because there will be little change in soft drink prices
E) a desirable policy because soft drink prices will rise

Handout 2 (Microsoft Word 2007 (.docx) 12kB Feb11 18)

After activity 1 note differences in group answers but do not attempt to evaluate them. Instead note the arguments made by groups, likely to include the fact that the individual writing the check for the tax may not bear the burden (the tax incidence), the ability of the landlord to pass along the cost increase, and the possible limit on the ability of the landlord to pass along the cost increase if the renter has alternatives. These issues prepare students for direct instruction about the impact of elasticity on the tax incidence.

The second activity requires the students to consider the price elasticities of demand and supply for soft drinks. Price elasticity of demand will depend on the availability of substitutes, the low price of soft drinks relative to income, and possibility different effects on different age and income groups. Price elasticity of supply is likely to be fairly inelastic in this market controlled by a few producers.

The second activity requires transfer of knowledge about elasticity and tax incidence to a new context. Additional applications in other contexts can be used to further reenforce the concepts.

For summary of US and other country taxes on sugar soft drinks see https://en.wikipedia.org/wiki/Sugary_drink_tax Typical taxes are 1 to 1.5 cents per ounce or about a 30% tax.

On a "time for telling" see chapter "J is for Just-in-Time Telling" in The ABCs of How We Learn by Daniel L. Schwartz, Jessica M. Tsang and Kristen P. Blair.