Elasticity and the Tax Burden

Tax incidence- the proportion of tax born

by buyers and sellers of the taxed product
Who will bear more of the tax burden?
Elasticity and the Tax Burden
If a product is taxed, there can be 3
possibilities

Price increase by the full tax amount

(buyers bear all the tax)
Price increase by less than the tax amount
(buyers and sellers share the tax)
Price does not change
(sellers absorb all the tax)
Elasticity and the Tax Burden
Refer to the article- Bade and Parkin

Case 1: Tax is equally shared between buyers

and sellers
Case 2: Given a normal upsloping supply curve,
consider a perfectly inelastic and perfectly
elastic demand
Case 3: Given a normal downsloping demand
curve, consider a perfectly inelastic and
perfectly elastic supply
 How the Burden of a Tax Is Divided

(a) Elastic Supply, Inelastic Demand

Price
1. When supply is more elastic
than demand . . .
Price buyers pay
Supply

Tax
2. . . . the
incidence of the
Price without tax tax falls more
heavily on
Price sellers consumers . . .
receive

3. . . . than
Demand
on producers.

0
Quantity
 How the Burden of a Tax Is Divided

(b) Inelastic Supply, Elastic Demand

Price
1. When demand is more elastic
than supply . . .
Price buyers pay Supply

Price without tax 3. . . . than on

consumers.
Tax

2. . . . the Demand
Price sellers incidence of
receive the tax falls
more heavily
on producers . . .

0
Quantity
 Elasticity And Tax Incidence

So, how is the burden of the tax divided?

• The burden of a tax falls more

heavily on the side of the
market that is less price elastic.