CASE STUDY ANALYSIS
THE SURPRISING ELASTICITY OF DEMAND FOR LUXURIES

Question 1:

The Government adopted 10% “luxury tax” on such big-ticket items as pleasure boats, private air planes, high-priced cars, jewels… since the assumption was that the demand for these luxury goods was quite inelastic. As shown in the graph above, when the tax is adopted, the supply curve shifts upwards and to the left. As the demand is assumed to be inelastic, the demand curve is steep, which leads to the large rise in equilibrium price and the relatively small fall in equilibrium quantity. Then, the rich people who does not response dramatically when there is a change in price would pay most of the tax.

However, the demand for these luxury goods is reasonable elastic, then the flatness of the demand curve and the upward shift in the supply curve leads to a much smaller rise in equilibrium price and a larger fall in equilibrium quantity (shown in the graph above). According to the theory of Supply, Demand & Elasticity, the buyers response very dramatically when there is a change in price of these luxury goods as they moved to buy substitute products to avoid paying this tax. The burden of this tax actually ended up falling on the workers and retailers who manufacture and sell these luxury goods, which means the purpose of the tax has failed.

Question 2:

“Luxury tax” is a good way to raise money from rich people. However, the fact points that the assumption of the elasticity of demand for these luxury goods is not correct. To some extent, it also shows that the government’s tax policy is not appropriate.
Firstly, the Congress adopted a 10% “luxury tax” which is an inappropriate tax. The Congress should have put lower tax like 4-5% or put 10% tax in some states in the first place then analysed the result to make next move.
The following problem in this policy is