Mexico's sugar tax appears to be having a significant impact for the second year running in changing the habits of a nation famous for its love of Coca-Cola, and will encourage countries troubled by obesity and contemplating a tax of their own.

An analysis of sugary-drink purchases, carried out by academics in Mexico and the United States, has found that the 5.5% drop in the first year after the tax was introduced was followed by a 9.7% decline in the second year, averaging 7.6% over the two-year period.

The study has been carried out by the University of North Carolina at Chapel Hill's Gillings School of Global Public Health and the Mexican Instituto Nacional de Salud Pblica (National Institute of Public Health). They found that the tax, which is just 1 peso per litre of sugary drink, had its biggest impact on the poorest households, where the decline in purchases was 18.8ml per person per day in 2014 and 29.3ml in 2015.

An earlier estimate of the price elasticity of demand for Sugar Sweetened Beverages (SSBs - defined as 'soft drinks, fruit juices, fruit drinks, flavored water and energy drinks') in Mexico, from Colchero et al (2015)1, estimated a price elasticity of demand of -1.16. The 1 peso per-unit tax was close to 10% of the price on average.

Task:

Explain, using a supply and demand model with a tax, two things about the outcomes observed.

1. With an elasticity of demand of -1.16, a 10% price increase would lead to a decrease in quantity demanded of 11.6%. Explain why we would generally *not* expect quantity demanded to fall by that much after the imposition of a tax of that magnitude.
2. Explain, with reference to elasticity, why it is not surprising that the drop was larger in the second year than in the first year.

Ensure that you use diagrams where relevant to support your answer, and make sure to use key terminology and course concepts where appropriate.