Principles of Economics- Mankiw (5th) 130

Principles of Economics- Mankiw (5th) 130 - 134 PA R T T W...

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134 PART TWO SUPPLY AND DEMAND I: HOW MARKETS WORK CASE STUDY WHO PAYS THE LUXURY TAX? In 1990, Congress adopted a new luxury tax on items such as yachts, private air- planes, furs, jewelry, and expensive cars. The goal of the tax was to raise rev- enue from those who could most easily afford to pay. Because only the rich could afford to buy such extravagances, taxing luxuries seemed a logical way of taxing the rich. Yet, when the forces of supply and demand took over, the outcome was quite different from what Congress intended. Consider, for example, the market for yachts. The demand for yachts is quite elastic. A millionaire can easily not buy a yacht; she can use the money to buy a bigger house, take a European va- cation, or leave a larger bequest to her heirs. By contrast, the supply of yachts is relatively inelastic, at least in the short run. Yacht factories are not easily con- verted to alternative uses, and workers who build yachts are not eager to change careers in response to changing market conditions. Our analysis makes a clear prediction in this case. With elastic demand and
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