Question

1. Draw how the burden of the tax is distributed under the following scenarios: a) Inelastic demand and elastic supply b) Elastic demand and inelastic supply c) Relative elasticities of demand and supply are similar In each diagram, clearly label: equilibrium price before the tax. price paid by buyers after the tax, price received by sellers after the tax, portion of tax burden on consumers, and portion of tax burden on producers.

Answer 1

Ans )

(a)

  When the demand is inelastic, and supply is elastic, the more burden of tax falls on the consumers and less burden falls on the sellers as there is negative relationship between the price elasticity and tax incidence .

As we can see in the diagram below, the green colored line indicates the tax burden that falls on consumers and the pink colored line indicates the tax burden that falls on the sellers.

Price before tax = P

Quantity before tax = Q

Price paid by consumers after tax = Pc

Price received by sellers after tax = Ps

Quantity after tax = Q'

Price ē o Ps Q Q Quantity

(b)

When the demand is elastic, and supply is inelastic, the more burden of tax falls on the sellers and less burden falls on the consumers as there is negative relationship between the price elasticity and tax incidence .

As we can see in the diagram below, the green colored line indicates the tax burden that falls on consumers and the pink colored line indicates the tax burden that falls on the sellers.

Price before tax = P

Quantity before tax = Q

Price paid by consumers after tax = Pc

Price received by sellers after tax = Ps

Quantity after tax = Q'

Price ps Quantity

(C)

When elasticities are relatively equal, then the incidence of tax is equal on both sellers and consumers.

As we can see in the diagram below, the green colored line indicates the tax burden that falls on consumers and the pink colored line indicates the tax burden that falls on the sellers.

Price before tax = P

Quantity before tax = Q

Price paid by consumers after tax = Pc

Price received by sellers after tax = Ps

Quantity after tax = Q'

Price QQ Quantity