A student asks…
When is the tax on a good paid entirely by buyers or sellers?
The short answer: For a tax on a good to be paid entirely by buyers, either demand must be perfectly inelastic, or supply must be perfectly elastic (or both). And for a tax on a good to be paid entirely by sellers, either demand must be perfectly elastic, or supply must be perfectly inelastic (or both).
What is perfectly elastic demand? Perfectly inelastic demand?
Suppose that the price of a good changes. If the percentage change in the quantity demanded of the good exceeds the percentage change in its price, the price elasticity of demand is greater than 1 (in absolute value) and the good has an elastic demand. And if the quantity demanded changes by an infinitely large percentage, the price elasticity of demand is infinity and the good has a perfectly elastic demand. The demand curve for such a good is a horizontal line. (See part (a) of Figure 1.)
Instead, if the percentage change in the price of the good exceeds the percentage change in its quantity demanded, the price elasticity of demand is between 0 and 1 (in absolute value) and the good has an inelastic demand. And if the quantity demanded remains constant when the price changes, the price elasticity of demand is 0 and the good has a perfectly inelastic demand. The demand curve for such a good is a vertical line. (See part (b) of Figure 1.)
Who pays the tax when demand is perfectly elastic?
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Who pays the tax when demand is perfectly inelastic?
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What is perfectly elastic supply? Perfectly inelastic supply?
If the percentage change in the quantity supplied of the good exceeds the percentage change in its price, the elasticity of supply is greater than 1 and the good has an elastic supply. And if the quantity supplied changes by an infinitely large percentage, the elasticity of supply is infinity and the good has a perfectly elastic supply. The supply curve for such a good is a horizontal line. (See part (a) of Figure 2.)
Instead, if the percentage change in the price of the good exceeds the percentage change in its quantity supplied, the price elasticity of supply is between 0 and 1 and the good has an inelastic supply. And if the quantity supplied remains constant when the price changes, the elasticity of supply is 0 and the good has a perfectly inelastic supply. The supply curve for such a good is a vertical line. (See part (b) of Figure 2.)
Who pays the tax when supply is perfectly elastic?
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Who pays the tax when supply is perfectly inelastic?
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