Figure 4-10

-Refer to Figure 4-10. Suppose the market is initially in equilibrium at price P₁ and now the government imposes a tax on every unit sold. Which of the following statements best describes the impact of the tax? For demand curve D₁

Question

Figure 4-10
 
-Refer to Figure 4-10. Suppose the market is initially in equilibrium at price P₁ and now the government imposes a tax on every unit sold. Which of the following statements best describes the impact of the tax? For demand curve D₁

Quizplus · Accepted Answer

When a tax is imposed, the supply curve shifts upward by the amount of the tax. This is represented by the shift from S₁ to S₂ in the figure. As a result, the equilibrium price paid by buyers increases from P₁ to P₂, while the price received by sellers (after tax) decreases from P₁ to P₃. The difference between P₂ and P₃ is the amount of the tax.

In this situation, the burden of the tax is shared between buyers and sellers. The size of each party's burden depends on the relative elasticities of demand and supply. In general, the party with the less elastic curve (i.e., steeper slope) bears a larger share of the tax burden.

Since demand curve D₁ is relatively elastic (i.e., flat slope), buyers are able to respond more easily to changes in price. Therefore, sellers (i.e., producers) will bear a larger share of the tax burden. The burden will be even larger if the supply curve is relatively inelastic (i.e., steep slope), as in S₁. Therefore, B is the correct choice.

Figure 4-10 -Refer to Figure 4-10. Suppose the Market Is Initially in Market