A government wants to raise revenue and improve health. It can raise the tax on one good this year. The price elasticity of demand differs for each.
Cigarettes (inelastic demand)
- Government: Revenue rises a lot, because most smokers keep buying.
- Health: Smoking falls only a little in the short run.
- Low-income smokers: They spend more of their income on a habit they struggle to break.
With inelastic demand the tax is good at raising revenue but weaker at cutting consumption.
Sugary drinks (elastic demand)
- Health: Many buyers switch to water or diet drinks, so sugar intake falls.
- Government: Less revenue, because far fewer drinks are bought.
- Drinks firms: Sales fall sharply unless they offer low-sugar versions.
With elastic demand the tax changes behaviour a lot but raises less revenue.
Rice (inelastic, a necessity)
- Government: Revenue is high and steady.
- Poor households: Rice is a large share of their spending, so the tax hits them hardest.
- Health: No health benefit, since rice is not a harmful good.
Taxing a necessity raises revenue but places a heavy burden on low-income households.