Figure 4-11
-Refer to Figure 4-11.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 4-11 
-Refer to Figure 4-11.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. This makes the equilibrium price increase to P2, which is higher than the initial price P1. As a result, the consumers face a higher price and reduce their quantity demanded regardless of which demand curve is applicable. However, the magnitude of the incidence of the tax on the consumer and the producer varies with the elasticity of demand and supply, respectively. In this case, the demand curve D2 is less elastic than D1, meaning that consumers are less sensitive to price changes. Therefore, they will bear a greater share of the tax burden in the case of D2 than D1. Alternatively, one could argue that since both demand curves are straight lines with the same slope, the tax incidence is split between consumers and producers in proportion to the elasticities, i.e., the degree of curvature of the curves. In that sense, the tax incidence is still higher for consumers if D2 is steeper than D1. Therefore, answer choice C is the most reasonable answer. Answer A is incorrect because it suggests that the demand curve affects the incidence of the tax, whereas it is the elasticity that matters. Answer B is incorrect because it states that the consumer's share of the tax burden is the same regardless of the demand curve, which is not generally true. Answer D is incorrect because it assumes that the tax incidence is always 100% on one side, which is not possible under realistic assumptions about demand and supply.

Figure 4-11 -Refer to Figure 4-11.Suppose the Market Is Initially in Equilibrium