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20. Suppose your uncle, State Senator Graft, tells you the following: "About a million packs of cigarettes and a million movie tickets are sold each month in the state. We are considering an excise tax of 50 cents on either cigarettes or movie tickets. I think it shouldn't matter which good we tax, we should get revenue of about $500,000 either way. What do you think?" After careful thought you give the following, correct, reply.

For almost every reason we expect demand for cigarettes to be more inelastic. The most important reason is that they are highly addictive and there are no close substitutes for them. Demand for movies, on the other hand, can be expected to be much more elastic because there are many good substitutes including video rentals and any other sort of entertainment. As we know, when a tax is imposed on a good with inelastic demand, quantity demanded falls by very little and tax revenue is higher than when demand is elastic.