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Question: 1. What is the meaning of tax incidence when a tax is levied on a market? Can you identify which economic lesson is applicable to taxing sugary drinks and briefly explain the economics behind this policy? 2. Draw a fully-labelled demand and supply diagram to represent the market for sugar-sweetened drinks.Illustrate the effect of a tax levied on consumers of sugar-sweetened drinks. Clearly label the changes you have made in your diagram and explain the impact on the equilibrium price and quantity following the introduction of the tax. Sugar is a key ingredient in the production of sugar-sweetened beverages. Draw a new fullylabelled diagram that represents the Australian sugar market and discuss the likely impact to this market of a tax being levied on sugar-sweetened drinks. Again, clearly label the changes you have made in your diagram and the effect on equilibrium price and quantity of sugar.The last part of this question looks at the likely impact of a tax on sugar-sweetened drinks on the market for non-sweetened, artificially sweetened or low-sugar beverages. Draw a fully-labelled diagram that represents these combined markets and discuss the likely impact of the introduction of a sugary drinks tax, explaining the economic relationship between these markets and the sugar-sweetened drinks market. 3. According to a report by the Grattan Institute (Duckett and Swerissen, 2016), it was estimated that the own price elasticity of demand for sugar-sweetened beverages was. Briefly interpret this elasticity estimate and discuss its relationship to the effectiveness of a tax on the consumption of sugar-sweetened drinks.Most studies show that sugary drinks are consumed in high proportions by children and teenagers, as well as low-income households. How would these consumer characteristics help to improve the effectiveness of a consumption tax on sugary drinks? Answer: Answer 1 Answer i When government levies a tax, it creates burden on relevant group directly or indirectly (Mankiw 2014). In terms of economics, the distribution of direct or indirect tax burden between buyers and sellers is known as incidence of the imposed tax. Answer ii Before imposing any tax, the impact of the proposed tax should be evaluated in terms of supply, demand and their respective elasticity. This is studied in the microeconomic lesson-containing concept of elasticity of demand and supply and incidence of taxation. The main economic rationale behind imposition of any tax is to put some indirect restriction on particular activity. More consumption of sugary drinks is bad for health and lead to several health hazard (Case, Fair and Oster 2014). Therefore, government aims at reducing the consumption of sugar through sugary drinks. To achieve this objective sugary drinks are taxed. Answer 2 Answer i Figure 1: Tax on buyers of sugary drinks (Source: as created by Author) The figure above represents the market for sugar-sweetened drinks. MM shows the demand curve without tax and NN shows that of the supply curve. Before tax, in the market Q1 amount drinks sold at price P1. The market equilibrium is at E. When a tax of the rate t is imposed on consumer then the immediate impact is on the market demand curve (Pindyck and Rubinfeld 2015). The tax shifts the market demand curve by the amount of tax. M1M1. The new equilibrium is set I. PS is the price obtained by the seller. Because of tax, buyers now have to a high price of PB. Tax discourages both the buyers and sellers in the market and consequently equilibrium quantity sold in the market reduced to QT from an earlier Q1. From the tax government receives a tax revenue of the amount (PB - PS)*QT. Answer ii Figure 2: Effect of a sugary tax in the sugar market (Source: as created by the Author) In sugary drinks, sugar is the key components. Any changes in market for such drinks leads to a change in sugar market as well. Sugar and sugar drinks have a complementary relation. For complementary goods, demand for the two goods move in the same direction. That means increase in price of one good reduces its demand as well as the demand for its complementary good (Perloff 2017). Figure 2 presents the scenario in the sugar market. As shown above, a tax on sugar drinks reduces quantity sold in the market. As a lower quantity of sugary drinks is produced, the main input demand that is sugar demand reduces. The decrease in demand leads to a decline in price from P* to P1and decreases quantity in the market from Q* to Q1. Answer iii Figure 3: Effect on non-sweetened, artificially sweetened and low sugar beverages (Source: as created by the Author) A tax on sugary drinks raises the cost to consumers of such drinks. Owing to a high price, consumers of sugar drinks now attempts to substitute sugar-sweetened drinks with drinks that are artificially sweetened, low sugared or non-sweetened. Therefore, demand of sugar substitute drinks will increase (Hubbard et al. 2015). This is shown by the rightward shift in the market demand curve of the substitute product from M0M0 to M1M1. As a result, these markets will expand with an increase in price and quantity sold. Answer 3 Answer i Own price elasticity of demand captures the percentage change in demand with respect to a percentage change in own price. The elasticity measure is particularly important in determining the extent of tax burden (Krugman et al. 2015). The estimated elasticity of sugar-sweetened beverages is -0.9. That means when price of such drinks raises by 1% then its demand will be reduced by 0.9%, which is close to 1. The governments objective of levying tax on sugary beverages is to reduce consumption of such beverages. When tax raises price of sugary drinks then consumers will reduce 90% of their demand. This fulfills governments objective of consumption reduction of sugary beverages. As buyers are able to reduce their demand almost to the extent of tax, most of the burden will be borne by suppliers. This discourages production of sugary drinks. Hence, own price elasticity of sugary beverages of -0.9 make the imposed tax very effective in reducing consumption and production. Answer ii As revealed by studies, sugary beverages are mostly consumed by consumer group consisting of children, teenagers and low income household. Own price elasticity depends on a number of factors. Income of the consumers group is one important factor affecting elastic response of demand (Parkin and Bade 2015). Consumer having limited income generally have a highly elastic demand. A rise in price means greater reduction in real income of this group. As a result, they reduce their demand largely when price increases and try to use cheap substitute product (Dixit 2014). Children and teenagers have income limited by their pocket money. Therefore, when proposed tax raises price then their affordability for sugary beverages reduce and so is the demand. Similar is the case for low income household. Because of low income, increase in sugar price make them more responsiveness and there will be considerable decline in demand. References Case, K.E., Fair, R.C. and Oster, S., 2014.Principles of Microeconomics. Pearson Higher Ed. Dixit, A., 2014.Microeconomics: A very short introduction. OUP Oxford. Hubbard, G., Garnett, A., Lewis, P. and O'Brien, T., 2015.Microeconomics. Pearson Australia. Krugman, P., Wells, R., Au, I. and Parkinson, J., 2015.Microeconomics: Canadian Edition. Macmillan Higher Education Mankiw, N.G., 2014.Principles of macroeconomics. Cengage Learning. Parkin, M. and Bade, R., 2015. Introduction to Microeconomics. Perloff, J.M., 2017.Microeconomics: theory and applications with calculus. Pearson Higher Ed. Pindyck, R.S. and Rubinfeld, D.L., 2015. Microeconomics; Eight Edition, Global Edition.