Economics Online Tutor
| Tax Incidence and Elasticity |
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The combination of the price elasticity of demand and the price elasticity of
supply will determine whether the consumer or the firm pay for a given tax
increase.
A tax on the sale of goods (sales tax, excise tax) will ultimately be paid by
either the consumer or the firm based on elasticities, regardless of who the
government actually levies the tax on.
If the consumer ultimately pays the tax, it means that the tax incidence falls on
the consumer. If the firm ultimately pays the tax, it means that the tax
incidence ultimately falls on the firm.
The less elastic the demand and more elastic the supply, the more the tax
incidence falls on the consumer.
The more elastic the demand and the less elastic the supply the more the tax
incidence falls on the firm.
This is because with an inelastic demand, consumers will tend to spend more
money with a tax increase. The decrease in the quantity purchased will be
less than the increase in the tax. But with an elastic demand, consumers will
purchase a smaller quantity with a tax increase, leaving firms to pay for the tax
increase with lower revenue.
To the extent that consumers pay the tax, business costs and revenues will
not be affected. To the extent that businesses pay the tax, the tax represents
a cost of production, and supply will be decreased.
supply will determine whether the consumer or the firm pay for a given tax
increase.
A tax on the sale of goods (sales tax, excise tax) will ultimately be paid by
either the consumer or the firm based on elasticities, regardless of who the
government actually levies the tax on.
If the consumer ultimately pays the tax, it means that the tax incidence falls on
the consumer. If the firm ultimately pays the tax, it means that the tax
incidence ultimately falls on the firm.
The less elastic the demand and more elastic the supply, the more the tax
incidence falls on the consumer.
The more elastic the demand and the less elastic the supply the more the tax
incidence falls on the firm.
This is because with an inelastic demand, consumers will tend to spend more
money with a tax increase. The decrease in the quantity purchased will be
less than the increase in the tax. But with an elastic demand, consumers will
purchase a smaller quantity with a tax increase, leaving firms to pay for the tax
increase with lower revenue.
To the extent that consumers pay the tax, business costs and revenues will
not be affected. To the extent that businesses pay the tax, the tax represents
a cost of production, and supply will be decreased.
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