1. Price Elasticity and Tax Incidence
Chapter 5 Appendix
Price Elasticity and Tax Incidence
© 2006 Thomson/South-Western

2. Exhibit 13: Effect of Different Demand Elasticities on Sales Tax Incidence

3. Exhibit 13: Effect of Different Demand Elasticities on Sales Tax Incidence
(a) Less elastic demand
Before the tax is imposed, the intersection of demand and supply yields a market price of $1.00 per ounce and a market quantity of 10 million ounces per day
A tax of $0.20 is imposed on each ounce sold and must be added to the original supply curve to get a supply curve that includes the tax
The shift in the supply curve from S to St reflects the decrease in supply resulting from the tax St S
$1.15
$1.00
$0.20 Tax
Price per ounce D
Millions of
ounces per day 9 10

4. Demand Elasticity and Tax Incidence
(a) Less elastic demand
Tax raises equilibrium price from $1.00 to $1.15 and decreases equilibrium quantity from 10M to 9M ounces
Consumers pay $0.15 more per ounce and producers receive $0.05 less after the tax
The top area represents the portion of the tax paid by consumers
The bottom area represents the portion of the tax paid by producers St S
$1.15
$1.00
$0.20 Tax
0.95
Price per ounce D 9 10
Millions of
ounces per day

5. Demand Elasticity and Tax Incidence
(b) More elastic demand
Demand is more elastic - the price increases from $1.00 to $1.05
Sellers cannot easily pass the tax along as a higher price, their revenues decline from $1.00 to $0.85
Top area represents the portion of the tax paid by consumers
Bottom area represents the portion of the tax paid by sellers St S
$1.05
$0.20 Tax
$1.00
0.85 D
Price per ounce 7 10
Millions of
ounces per day

6. Demand Elasticity and Tax Incidence
The more price elastic the demand
the more the tax is paid by producers
the less it’s passed on to consumers as a higher price
The less price elastic the demand
the more the tax is paid by consumers as a higher price
the less it’s paid by producers
Tax revenues will be lower when the tax is levied on goods or services with demand that is elastic

7. Exhibit 14: Effects of Different Supply Elasticities on Sales Tax Incidence

8. Supply Elasticity and Tax Incidence
The more elastic the supply, the less the tax is paid by producers as a lower net-of-tax receipt and the more is passed on to consumers as a higher price
The less elastic the supply, the more the tax is paid by producers as a lower net-of-tax receipt and the less is passed on to consumers as a higher price