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ACCA Applied Skills · Financial Management · The economic environment for business

A government introduces a tax of $4 per unit on a product whose demand is highly price inelastic and whose supply is relatively elastic. Which statement about the incidence of the tax is correct?

Consumers will bear most of the burden. When demand is inelastic, buyers keep purchasing despite a higher price, so sellers can pass most of the tax on, while elastic supply means producers can withdraw output if they absorb it. The less elastic side bears more of the tax.

  1. AConsumers will bear most of the tax burden through higher pricesCorrect
  2. BProducers will bear most of the tax burden through lower net prices
  3. CThe burden will be shared exactly equally
  4. DThe tax will have no effect on the equilibrium price

Explanation

The side of the market that is less elastic bears more of the tax. Inelastic demand means buyers cannot easily reduce purchases, so producers can pass most of the tax on in the price. If supply were inelastic and demand elastic, producers would bear more. An equal split only occurs with equal elasticities.

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