1a. The sales manager of a retail outlet suggests that the best way to increase

Question

1a. The sales manager of a retail outlet suggests that the best way to increase the number of customers is to have a sale. If a 10 percent price cut doesn’t bring in enough customers, then he’ll cut prices 20 percent. Increased cash flow should take care of profits. Do you agree? Explain.

1b. How would a  proposed increase in cigarette taxes succeed according to the following criteria: collecting a large amount of tax revenue; distorting demand as little as possible; discouraging consumption of harmful commodities?

Explanation / Answer

1a

it will all depend on the price elasticity of demand. A price cut might result in decline in overall revenues if the demand is inelastic. So this strategy of providing discount can work in situations when demand is elastic.

1b

Lets assume demand for cigarette is inelastic among adults, in this case taxes will work in a sense that price will increase due to taxes, but demand will not change, so the government will collect higher taxes. This tax is also bodes well for not distorting the demand as consumption will reduce by fraction for a decent increase in price. This tax also will discourage the consumtion of harmful products due to higher prices, but to very minor extent as demand is inelastic.

Lets take case of younger smokers who generally has more elastic demand for cigarettes, so tax led increase in prices will reduce demand to large extent and government revenues might not increase the same way as it did in case of adults. In fact governmnent tax revenues might decline. This is also the case of demand distoration which is probably the one key idea behind tax on harmful commodities.

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