Microeconomics – Tax Incidence

(1 ) Indicate the reason for the given answer to question 6 and what the elasticities can mean for whether consumers or the producers bear the greater burden

With Z being the efficiency , T being the excise tax , Q being the quantity ,

being the price , Ed being the elasticity of demand and Es being .the elasticity of supply , the efficiency and elasticity are related according to the following formulas

The above equation , like the answer to question 6 , suggests that as the tax increases the efficiency increases with the square of the [banner_entry_middle]

tax . The reason for this is that when tax of a good is increased , it reduces the equilibrium of the price because less will be demanded due to the price increase added by the tax . The meaning of this is that , as the tax is increased , the producer and the consumer bear the burden of the tax depending on the elasticity of the supply and demand

To get the relationship of elasticity of demand Ed and elasticity of supply Es , we get the partial derivatives with respect to Ed and Es of the above equation

These equations since they are both positive , like the answer to question 6 , suggest that increasing either elasticity Ed or Es causes an increase in the efficiency loss

The meaning of these is that if demand for a product is more inelastic than its supply the consumers will carry the greater burden with little change in what they buy . This is because the consumer will still buy the product because the demand is inelastic

Conversely if the demand for a product is much more elastic than supply the producer will carry most of the burden of the tax . This is because they cannot pass the price to the consumer otherwise no one will buy and more profit will be lost (2 ) what it might mean for a `political entrepreneur` attempting to win votes on taxation issues

This means that a political entrepreneur must consider the elasticity of supply and demand for a certain good , before suggesting a certain level of tax . He /she would always consider on lowering the tax , to reduce the efficiency loss

References

C . MacConnell , S . Brue (2005 . Economics : Principles , Problems , and Policies , 16 /e . Graphing Exercire : Tax Incidence (Chapter 31 . Retrieved Dec 9 2006 from http /highered .mcgraw-hill .com /sites /student_view0 /chapter31 /interactive_graphs .html… [banner_entry_footer]