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Elasticity and tax incidence

D

Divyansh Verma

Member
"The more elastic the supply, the greater the price increase (the greater the consumer burden) and the greater the fall in quantity sold (and hence the lower the tax revenue)." (Page 10, CT7-PC-17)

Is the above statement correct, please justify?
 
Yes, this is right. Try drawing the diagram on page 9 using the same demand curve but different supply curves (try one very steep supply curve and one very flat one). Remember that the supply curve moves upwards vertically by the amount of the tax. You should find that the price increases more and the quantity falls more, the more elastic is the supply. This is because the more elastic the supply, the more important price is to the producer, so the producer will try to pass it on to the consumer. If the supply is perfectly elastic (horizontal) the producer only produces at one price. If a tax is added, the producer has to receive the same price or will not supply anything, so the price goes up by the full amount of the tax, ie the consumer bears it all.
 
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