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IAI Actuarial Core Principles · Business Economics · Government intervention in a market

A government imposes a per-unit tax on a good for which demand is perfectly inelastic and supply is upward sloping. Who bears the burden of the tax?

Consumers bear the whole tax. When demand is perfectly inelastic, buyers do not cut quantity as price rises, so sellers can pass the entire per-unit tax into the market price, leaving the producers' net receipt per unit unchanged.

  1. AConsumers bear the whole burden through a higher priceCorrect
  2. BProducers bear the whole burden through a lower net price
  3. CThe burden is split equally between consumers and producers
  4. DNeither party bears any burden because quantity is unchanged
  5. The government bears the burden through lost revenue

Explanation

With perfectly inelastic demand, consumers cannot reduce purchases when the price rises. The full tax is therefore passed on in the market price, so consumers pay all of it. Producers' net price is unchanged, so option B is wrong.

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