Question

The supply of aged cheddar cheese is inelastic, and the supply of bread is elastic. Both goods are considered to be normal goods by a majority of consumers. Suppose that a large income tax increase decreases the demand for both goods by 10%. Refer to Scenario 5-3. The equilibrium price will a. increase in both the aged cheddar cheese and bread markets. b. increase in the aged cheddar cheese market and decrease in the bread market. c. decrease in the aged cheddar cheese market and increase in the bread market. d. decrease in both the aged cheddar cheese and bread markets.

Answer 1

Answer:

The correct answer is option d.

Explanation:

The supply of aged cheddar cheese is inelastic, and the supply of bread is elastic. Both goods are normal goods.  

The imposition of income tax decreases the demand for both the goods by 10%. This decrease in the demand for goods will cause the price to decrease.  

The elasticity of supply, in this case, will not affect the change in price. The elasticity of supply will only affect the equilibrium quantity.  

Since the elasticity of supply is higher for bread, the quantity supplied will decrease to a greater extent as compared to cheese as it has inelastic supply.