Page 665 - Economics

CONFIRMING PAGES

PART EIGHT
574
Microeconomics of Government
P P FIGURE 29.3 Demand elasticity and
S t S t
the incidence of an excise tax. (a) If
Tax S Tax S demand is elastic in the relevant price range, price
rises modestly ( P 1 to P e ) when an excise tax is levied.
Hence, the producer bears most of the tax burden.
a (b) If demand is inelastic, the price to the buyer
a P i
P e increases substantially ( P 1 to P i ) and most of the tax
is shifted to consumers.
P 1 P 1 b
b
D e P b c
c
P a
D i
0 Q 2 Q 1 Q 0 Q 2 Q 1 Q
(a) (b)
Tax incidence and elastic Tax incidence and inelastic
demand demand

is the basis of our previous applications of the elasticity (such as an extraction tax) would mainly fall on producers.
concept: Revenue-seeking legislatures place heavy excise On the other hand, because the supply of baseballs is rela-
taxes on liquor, cigarettes, automobile tires, telephone ser- tively elastic, producers would pass on to consumers much
vice, and other products whose demand is thought to be of an excise tax on baseballs.
inelastic. Since demand for these products is relatively in-
elastic, the tax does not reduce sales by much, so the tax Efficiency Loss of a Tax
revenue stays high. We just observed that producers and consumers typically
The second generalization is that, with a specific de- each bear part of an excise tax levied on producers. Let’s
mand, the more inelastic the supply, the larger is the por- now look more closely at the overall economic effect of
tion of the tax borne by producers. When supply is elastic the excise tax. Consider Figure 29.5 , which is identical to
( Figure 29.4a ), the producers shift most of the tax ( P P ) Figure 29.2 but contains the additional detail we need for
1
e
to consumers and bear only a small portion ( P P ) them- our discussion.
1
a
selves. But where supply is inelastic ( Figure 29.4b ), the re-
verse is true: The major portion of the tax ( P P ) falls on Tax Revenues In our example, a $2 excise tax on wine
1
b
sellers, and a relatively small amount ( P P ) is shifted to increases its market price from $8 to $9 per bottle and re-
i
1
buyers. The equilibrium quantity also declines less with an duces the equilibrium quantity from 15 million bottles to
inelastic supply than it does with an elastic supply. 12.5 million. Government tax revenue is $25 million (
Gold is an example of a product with an inelastic sup- $2 12.5 million bottles), an amount shown as the rect-
ply and therefore one where the burden of an excise tax angle efac in Figure 29.5 . The elasticities of supply and
P P FIGURE 29.4 Supply elasticity and
S t S
the incidence of an excise tax. (a) With
elastic supply, an excise tax results in a large price
S t increase ( P 1 to P e ) and the tax is therefore paid mainly
Tax Tax by consumers. (b) If supply is inelastic, the price rise
a is small ( P 1 to P i ) and sellers bear most of the tax.
P e S a
b
P 1 P i
b
c P 1
P a
c
P b
D D
0 Q 2 Q 1 Q 0 Q 2 Q 1 Q
(a) (b)
Tax incidence and elastic Tax incidence and inelastic
supply supply

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