A government imposes a tax on petrol, raising its price by 10%. Research shows that the price elasticity of demand for petrol is −0.3. Which of the following best describes the likely outcome for government tax revenue from petrol?

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Question

A government imposes a tax on petrol, raising its price by 10%. Research shows that the price elasticity of demand for petrol is −0.3. Which of the following best describes the likely outcome for government tax revenue from petrol?

Accepted Answer

Tax revenue will rise because demand is inelastic — Award 1 mark for correct answer. A PED of −0.3 means demand is price inelastic (|PED| < 1), so a 10% price rise causes only a 3% fall in quantity demanded. The proportional rise in price is greater than the proportional fall in quantity, so total spending — and therefore tax revenue — increases. A is incorrect because a PED of −0.3 indicates inelastic, not elastic, demand. C is incorrect because the reasoning about substitutes, while partially valid, does not explain the revenue outcome and is not the mechanism required. D is incorrect because inelastic demand means consumers are relatively unresponsive to the price change in the short run.

Answer

Tax revenue will fall significantly because demand is elastic

Answer

Tax revenue will remain unchanged because petrol has no substitutes

Answer

Tax revenue will fall because consumers will switch to alternative fuels immediately

Answer

Tax revenue will rise because demand is inelastic

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