Skip to content

IAI Actuarial Core Principles · Business Economics · How competitive markets operate

The government imposes a per-unit tax on a good. The market demand is perfectly inelastic in the short run, and supply is upward sloping and elastic. Which statement about the incidence of the tax is correct?

Consumers bear the entire burden. A per-unit tax shifts supply upward, but if demand is perfectly inelastic, buyers do not reduce quantity, so the market price rises by the full tax amount. Producers receive the same net price as before and pay none of it.

  1. AProducers bear the entire burden of the tax
  2. BConsumers bear the entire burden of the taxCorrect
  3. CThe burden is shared equally between consumers and producers
  4. DNobody bears the burden because quantity does not change
  5. The burden falls on the government through lower tax revenue

Explanation

The tax shifts the supply curve up by the amount of the tax. With perfectly inelastic demand, quantity is unchanged and the price rises by the full amount of the tax. Consumers therefore pay all of it. Equal sharing happens only when elasticities are similar, which is not the case here.

Did you get it right without looking?

One question tells you little. A timed set on How competitive markets operate shows your real accuracy, how long you take and where you lose marks.

Practise How competitive markets operateFree diagnostic mock

More How competitive markets operate questions