The government of Granita is thinking about imposing a very small tax on one or more of the following goods: anvils, books, and cardigans. Anvils and books are both produced in competitive markets with constant marginal costs, while cardigans are produced by a monopoly with constant marginal costs. The elasticities of demand for the three goods are −3, −1.5, and −1.2, respectively. What good or goods should the government put the very small tax on if it wants to minimize the deadweight burden?

The government should tax Anvils and books but not cardigans

Explanation:

A perfect competition is characterised by many buyers and sellers of homogenous goods and services. Market prices are set by the forces of demand and supply.

A monopoly is when there is only one firm operating in an industry. The firm sets the market price for its good and services. The firm earns economic profit in the short and long run.

When the absolute value of elasticity is greater than 1, it means that demand is price elastic.

Elastic demand means a small change in price leads to a greater change in quantity demanded.

Deadweight loss refers to the loss in efficiency as a result of tax.

A competitive market produces as the social optimum, so the effect of tax would be very small but because the monopoly operates below social optimum, the cost of tax would be high.

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