Figure 4-17
-Refer to Figure 4-17.Suppose the market is initially in equilibrium at price P1 and then the government imposes a tax on every unit sold.Which of the following statements best describes the impact of the tax?

Question

Figure 4-17 
-Refer to Figure 4-17.Suppose the market is initially in equilibrium at price P1 and then the government imposes a tax on every unit sold.Which of the following statements best describes the impact of the tax?

Quizplus · Accepted Answer

When a tax is imposed on every unit sold, the supply curve shifts upward by the amount of the tax. As a result, the new equilibrium price rises to P2, which is higher than the pre-tax price P1. The difference between the pre-tax price and the post-tax price represents the amount of tax, which is shared by both the producers and consumers. Since the demand curve is downward sloping, the tax reduces the quantity demanded by consumers. As a result, the consumer surplus decreases and the producer surplus increases, but by different amounts. The extent to which the tax burden is shared between the consumers and producers depends on the relative elasticities of demand and supply. If demand is relatively inelastic and supply is relatively elastic, as in panel (c), the consumer will bear a greater share of the tax burden because they are less responsive to changes in price. On the other hand, if demand is relatively elastic and supply is relatively inelastic, as in panel (a), the producer will bear a greater share of the tax burden because they are less able to adjust their output in response to a change in price. Therefore, choice C is the best answer.

Figure 4-17 -Refer to Figure 4-17.Suppose the Market Is Initially in Equilibrium