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CA Foundation · Business Economics · Public Finance

When the Government of India increases the rate of Goods and Services Tax (GST) on a particular service from 12% to 18%, and demand for that service remains virtually unchanged despite the price increase, this scenario suggests that:

Inelastic demand for a service means that quantity demanded does not respond much to price changes. When the GST rate increases from 12% to 18% and demand remains virtually unchanged, it indicates inelastic demand, allowing producers to pass the tax burden onto consumers who have few substitutes available.

  1. AThe service has highly elastic demand and the tax is regressive
  2. BThe service has inelastic demand and the incidence of tax falls heavily on consumersCorrect
  3. CThe service has unitary elastic demand and burden is equally shared
  4. DThe service has perfectly elastic demand and producers bear the entire tax incidence

Explanation

When quantity demanded does not respond significantly to a price increase, demand is inelastic (low price elasticity). With inelastic demand, consumers cannot easily substitute away from the service, so the tax incidence (burden) falls primarily on the consumer rather than the producer. The producer can pass most of the tax increase to consumers. GST is also regressive as a proportion of income, but the key economic concept here is the relationship between demand elasticity and tax incidence.

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