Prior to any taxes, the equilibrium price of bottled water is $5 per gallon. Then a $1-per-gallon tax is levied. As a result, the price of bottled water rises to $5.75 per gallon. The incidence of the $1 tax is _____ paid by consumers and _____ paid by producers.

Question

Quizplus · Accepted Answer

When a tax is levied, the incidence depends on the elasticity of demand and supply. In this case, the price elasticity of demand for bottled water is likely to be low as it is a necessity and there are few substitutes, while the price elasticity of supply is likely to be high as there are many producers who can easily switch to other goods. Therefore, the tax burden falls more heavily on consumers than on producers. Using the formula for tax incidence, we can find that the tax incidence on consumers is ($5.75-$5)/($1)= $0.75 and the tax incidence on producers is ($1-$0.75)= $0.25. Therefore, the answer is (D) $0.75; $0.25.

Prior to Any Taxes, the Equilibrium Price of Bottled Water