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Difficulty: MediumIncidence and Effects of Taxation

Suppose the government imposes a specific sales tax on an essential commodity for which consumer demand is perfectly inelastic (Ed=0E_d = 0) and market supply is price elastic (Es>0E_s > 0). Who bears the economic incidence of this tax?

  1. The entire tax burden falls on consumers because the market price rises by the full amount of the tax.Answer
  2. B
    The entire tax burden falls on producers because supply is elastic.
  3. C
    The tax burden is shared equally between consumers and producers.
  4. D
    Consumers bear a smaller share of the tax burden than producers.

Answer

The entire tax burden falls on consumers because the market price rises by the full amount of the tax.
When demand for a product is perfectly inelastic (Ed=0E_d = 0), consumers purchase the same quantity regardless of price. As a result, sellers can increase the market price by the full amount of the tax, passing the entire economic burden of the tax onto consumers.

Step-by-Step Solution

1
Analyze the elasticity of demand given in the question stem.
Demand is perfectly inelastic (Ed=0E_d = 0), meaning buyers will purchase the same quantity regardless of price increases.
The relative price elasticities of demand and supply determine how an indirect tax burden is distributed between consumers and producers.
2
Determine price adjustment and tax shifting behavior.
Producers raise the market price by the exact per-unit tax amount.
Because consumers cannot reduce their quantity demanded, producers can shift 100% of the tax forward to consumers.

Key Concept

Tax Incidence and Price Elasticity of Demand
Estimated Time:1m 0s
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Topics

Incidence and Effects of Taxation

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