Prior to any taxes,the equilibrium price of gasoline is $3 per gallon.Then a $1-per-gallon tax is levied.As a result,the price of gasoline rises to $3.75 per gallon.The incidence of the $1 tax is _____ paid by consumers and _____ paid by producers.

Question

Quizplus · Accepted Answer

When a tax is imposed on a good, the burden of the tax is shared between consumers and producers, but the actual incidence of the tax depends on the price elasticity of demand and supply. In this case, the tax is $1 per gallon, and the price of gasoline increases from $3 to $3.75 per gallon, which is a 25% increase.

If the demand for gasoline is relatively inelastic, consumers will bear most of the tax burden. However, if the supply of gasoline is relatively inelastic, producers will bear most of the tax burden.

Given the information in the question, we cannot determine the price elasticities of demand and supply, so we have to use some assumptions. Since the equilibrium price of gasoline is $3 per gallon, we can assume that the supply of gasoline is relatively elastic, because if it were inelastic, the equilibrium price would be higher. Similarly, we can assume that the demand for gasoline is relatively inelastic, because if it were elastic, the equilibrium price would be lower.

Under these assumptions, we can conclude that consumers will bear most of the tax burden, because they have to pay a higher price for gasoline even though the supply curve is relatively elastic. Producers' revenue per gallon after the tax is $2.75 ($3.75 - $1), which is only 75 cents lower than before the tax. Therefore, producers will bear a smaller share of the tax burden than consumers.

To summarize, the incidence of the $1 tax is $0.75 paid by consumers and $0.25 paid by producers. Therefore, the best choice is D.

Prior to Any Taxes,the Equilibrium Price of Gasoline Is $3