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ACCA Applied Knowledge · Business and Technology · Microeconomic factors

A government imposes a per-unit tax on a product with highly inelastic demand and fairly elastic supply. Which statement best describes the outcome?

Consumers bear most of the tax. When demand is highly inelastic and supply is relatively elastic, buyers keep purchasing despite higher prices, so sellers can pass nearly the whole tax on. Tax incidence falls mainly on the less price-responsive side of the market, rather than being split equally.

  1. AProducers bear most of the tax burden because they must lower their prices
  2. BConsumers bear most of the tax burden because the price rises by nearly the full taxCorrect
  3. CThe tax burden is shared equally whatever the elasticities

Explanation

Tax incidence falls mainly on the side of the market that is less responsive to price. With inelastic demand, consumers keep buying despite the higher price, so producers can pass most of the tax on. Equal sharing occurs only in special cases, not generally.

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