Case Study: The Incidence of Tax on a Local Restaurant
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This case study examines the incidence of a new tax on a local restaurant, "Taste Haven." The case presents a scenario where a small town implements a new tax, and the owner, Raj, has to determine whether to absorb the tax or pass it on to customers. The analysis involves identifying who ultimately bears the burden of the tax and deciding on an optimal pricing strategy by considering the elasticity of demand and other long-term business implications.
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Case Study: The Incidence of Tax on a Local Restaurant In a small town, the local government introduces a new tax on restaurants, aimed at generating additional revenue for community services. The tax is a fixed percentage applied to each restaurant's revenue. A popular restaurant, "Taste Haven," wh...
Case Study: The Incidence of Tax on a Local Restaurant In a small town, the local government introduces a new tax on restaurants, aimed at generating additional revenue for community services. The tax is a fixed percentage applied to each restaurant's revenue. A popular restaurant, "Taste Haven," which offers mid-priced meals, finds itself affected by this new tax policy. Before the tax, the price of an average meal at Taste Haven was $20, and the restaurant served about 200 customers per day, generating $4,000 in daily revenue. With the new 10% tax on their revenue, the restaurant now has to pay $400 per day in taxes. The owner of Taste Haven, Raj, faces a dilemma. He could increase menu prices to offset the tax, which would transfer the tax burden to customers. However, Raj is concerned that increasing prices may drive customers away, leading to a decrease in sales. Alternatively, he could absorb the tax himself, but this would reduce his profits significantly. Raj decides to increase the price of an average meal by $1, making the new price $21. As expected, the increase causes some customers to visit less frequently. The number of customers drops to 180 per day, reducing daily revenue to $3,780. After paying the $378 in taxes, Raj realizes that his post-tax profit margin has decreased compared to the pre-tax period. Raj begins to wonder whether it was better to absorb the tax or to pass it on to customers. He also thinks about how the tax affects other stakeholders: customers, the local economy, and his restaurant’s long-term competitiveness. Questions: 1. Who ultimately bears the burden of the new tax in this scenario, and how does it affect Taste Haven’s pricing strategy? 2. Discuss how the elasticity of demand for Taste Haven’s meals influences the effectiveness of passing the tax burden to customers. 3. What factors should Raj consider when deciding whether to absorb the tax or pass it on to his customers, and how might these factors affect his business in the long run?
