Tax Incidence

Per unit tax If a per unit tax t is imposed on a good, the consumer has to pay an extra amount of t for every unit of the good bought. P t

Per unit tax To the consumer, the supply curve is moved up by a vertical distance of t. S1 t S0 P Q

Per unit tax Before the tax is imposed, the consumer is paying P1 for every unit of the good. P Q D S0 P1 Q1 P1

Per unit tax When t is imposed, the consumer has to pay more than before for each unit of the good. S1 t P Q D S0 P1 Q1

Per unit tax The consumer will therefore buy less of the good (the Law of Demand). S1 P Q D S0 t P1 Q1

Per unit tax The consumer will therefore buy less of the good (the Law of Demand). S1 P Q D S0 t P1 Q1

Per unit tax The consumer will therefore buy less of the good (the Law of Demand). S1 P Q D S0 t P1 Q1

Per unit tax The consumer will therefore buy less of the good (the Law of Demand). S1 P Q D S0 t P1 Q1

Per unit tax The consumer will therefore buy less of the good (the Law of Demand). S1 P Q D S0 t P1 Q2 Q1

Per unit tax The consumer now pays P2 for each unit of the good. S1 P Q D S0 P2 t P1 Q2 Q1

Per unit tax P2 may be less than the sum of P1 and t. S1 P S0 t P2 P1 Q P2 Q1 Q2 P1

Per unit tax P2 may be less than the sum of P1 and t. P2 P1 t

Per unit tax P2 may be less than the sum of P1 and t. P2 t P1

Per unit tax P2 may be less than the sum of P1 and t. P2 t P1

Per unit tax P2 may be less than the sum of P1 and t. P2 P1 t

Per unit tax P2 may be less than the sum of P1 and t. P2 P1 t

Tax incidence In this case, the tax burden is said to be shared among the consumer and the producer. t

Tax incidence In this case, the tax burden is said to be shared among the consumer and the producer. t

Tax incidence In this case, the tax burden is said to be shared among the consumer and the producer. t

Tax incidence In this case, the tax burden is said to be shared among the consumer and the producer. t

Tax incidence In this case, the tax burden is said to be shared among the consumer and the producer. t

Tax incidence In this case, the tax burden is said to be shared among the consumer and the producer. t

Tax incidence In this case, the tax burden is said to be shared among the consumer and the producer.

Tax incidence For each unit of good, the consumer pays an extra amount of x. S1 P Q D S0 P2 x t P1 Q2 Q1

Tax incidence For each unit of good, the producer receives P3, which is less than P1 by y. S1 P Q D S0 P2 t y P1 P3 Q2 Q1

Summary

After imposition of the per unit tax (t), for each unit of the good, the consumer pays more (P2) while the producer receives less (P3). S1 P Q D S0 Q2 P2 Q1 P1 P3

The gap between the two amounts equals to the amount of the tax (t). D P Q Q1 P1 S1 Q2 P2 P3 t

The burden of the tax (t) is shared among the consumer (x) and the producer (y). Q Q1 P1 S1 Q2 P2 P3 t x y

The burden of the tax (t) is shared among the consumer (x) and the producer (y). Total Tax Burden S1 P Q S0 Consumer’s Share P2 x t P1 Producer’s Share y P3 D Q2 Q1

The distribution of the tax incidence between the consumer and the producer depends on the price elasticities of demand and supply. S0 D P Q Q1 P1 S1 Q2 P2 P3 t Consumer’s Share Producer’s Share x y

Activities With the help of supply and demand diagrams, show how the tax incidence is distributed when demand is elastic and supply is inelastic demand is inelastic and supply is elastic demand is perfectly elastic demand is perfectly inelastic supply is perfectly elastic supply is perfectly inelastic

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