Indirect taxes and elasticity

Question 1

How will the diagram for Price inelastic demand (PED<1) look?

Answer 1

• Steeper demand curve
• Shape of S curve remains the same
• Upwards shift of S1 curve –> Called S1 + Tax
• Distance between two curves represents tax / unit

Question 1

How will the diagram for Price elastic demand (PED>1) look?

Answer 1

• Shallow demand curve
• Shape of S curve remains the same
• Upwards shift of S1 curve –> Called S1 + Tax
• Distance between two curves represents tax / unit

Question 2

How will the diagram for Price elastic supply (PES>1) look?

Answer 2

• Shallow supply curve
• Shape of D curve remains the same
• Upwards shift of S1 curve –> Called S1 + Tax
• Distance between two curves represents tax / unit

Question 3

How will the diagram for Price inelastic supply (PED<1) look?

Answer 3

• Steep supply curve
• Shape of D curve remains the same
• Upwards shift of S1 curve –> Called S1 + Tax
• Distance between two curves represents tax / unit

Question 4

Explain the theory behind the diagram for PED>1

Answer 4

• Consumer Burden: Lower
• Producer Burden: Higher
• Gov. Revenue: Lower (fall in Q demanded is proportionally greater than increases in price)
• PED = ∞? Consumer burden is nothing as they are able to leave the market and buy alt. If the price rises by a greater amount, producers take the entire burden due to no changes in their prices and thus, they absorb the majority of the tax and gov. revenue will be the lowest

Question 5

Explain the theory behind the diagram for PED<1

Answer 5

• Consumer Burden: Higher
• Producer Burden: Lower (Producers feel they can transfer the indirect tax to prices without a massive loss in demand and revenue)
• Gov. Revenue: Higher (fall in Q demanded is proportionally lower than increases in price)
• PED = 0? Consumers take the entire burden as no alt. exist , the difference in price will be the exact value of the indirect tax, and producer burden is nothing as they can pass the prices to consumers in the form of higher prices thus, gov. revenue will be the highest

Question 6

Explain the theory behind the diagram for PES>1

Answer 6

• Consumer Burden: Higher
• Producer Burden: Lower (as producers can easily decrease the quantity they supply and thus, push the tax burden onto consumers in the form of higher prices)
• PES = ∞? (Supply curve is completely horizontal and if that is shifted upwards, the change in equilibrium and price is exactly equal to the value of the indirect tax thus, consumers take the entire burden and producers take nothing as they have greater ability to avoid the price changes by adjusting their supply to maintain their desired profits at the market price)

Question 7

Explain the theory behind the diagram for PES<1

Answer 7

• Consumer Burden: Lower
• Producer Burden: Higher (as if producers increased their prices, there is an unproportionately larger decrease in quantity demanded. producers also find it harder to decrease their production levels due to factors like high fixed costs)
• PES = 0? (Supply curve is completely vertical and cannot shift upwards thus, the producers take the entire burden as they can’t easily reduce supply and have to accept lower prices due to their factors being immobile and they can’t reallocate them elsewhere. Consumers take nothing as if the supply curve doesn’t shift there is no change in the equilibrium - consumers don’t have to accept higher prices as alternatives exist