Reference no: EM132422604

GingerSnap Cookies sell for $40 per box, of which $10 consists of tax, and 6,666 boxes are sold every year. From previous research, you know that the price elasticity of demand for GingerSnap Cookies is -1.2 (that is 1.2 in absolute value terms). All other cookies sell for $30 per box (which includes $l0 tax), and 4,000 boxes of other cookies are sold every year. The cross-price elasticity of demand for other cookies, with respect to a change in the price of GingerSnap Cookies, is 0.75. The income elasticity of demand is 2.1.

The government raises the tax on GingerSnap Cookies from $10 to $l2 per box all of which is passed through to the consumer in the form of higher prices of GingerSnap Cookies. As the tax is imposed, real income drops by 0.5%. Using the appropriate elasticity measures (price elasticity of demand, income elasticity of demand, and cross price elasticity of demand), calculate the change in total government revenue from the government raising the tax (and hence raising the price).

Required:

Question 1: Calculate the government revenue before and after the tax change. Explain by showing how you calculated the new P's and Q's for GingerSnap and other cookies after the change in tax was levied.

Question 2: Should the government raise the tax? Why or why not? Explain.

Question 3: Characterize the elasticities by types of goods and tell how a different characterization would change the outcome. (Hint: Think logically and set this up correctly for partial credit.)