Key Impacts of Indirect Tax and Elasticity

Introduction

• Discussion on how the impacts of indirect tax vary with elasticity.
• Focus on:
  • Consumer burdens
  • Producer burdens
  • Government revenue

Price Elasticity of Demand

Price Elastic Demand

• Diagram: Indirect tax diagram with shallow demand curve.
• Government Revenue Calculation:
  • Find new equilibrium at B.
  • Vertical distance BC = tax per unit.
  • Government revenue = P2BC * Quantity (up to Q2).
• Burden Distribution:
  • Consumer Burden: Portion P2 P1 BD.
  • Producer Burden: Remaining portion.
• Key Points:
  • Lower consumer burden.
  • Higher producer burden.
  • Lower government revenue due to significant drop in quantity (price elastic demand implies large fall in quantity).
• Perfectly Price Elastic Demand:
  • Consumer burden = 0; producers bear all burden.
  • Government revenue is lowest due to no price change.*

Price Inelastic Demand

• Diagram: Indirect tax with steeper demand curve.
• Government Revenue Calculation: Same process as elastic demand, revenue = P2 BCE.
• Burden Distribution:
  • Higher consumer burden.
  • Lower producer burden.
• Key Points:
  • Produces can raise prices significantly (inelastic demand means less fall in demand).
  • Higher government revenue since quantity doesn’t fall much.
• Perfectly Price Inelastic Demand:
  • Consumer burden is entire tax value.
  • Producer burden = 0.
  • Highest government revenue.

Price Elasticity of Supply

Price Elastic Supply

• Diagram: Normal demand curve, shallow supply curve.
• Process:
  • Shift supply curve upwards.
  • Higher consumer burden due to higher prices.
  • Lower producer burden.

Perfectly Price Elastic Supply

• Diagram: Horizontal supply curve.
• Process:
  • Shift supply upwards.
  • Consumer burden = entire tax (price increase equals tax value).
  • Producer burden = 0.

Price Inelastic Supply

• Diagram: Steep supply curve with normal demand curve.
• Process:
  • Shift supply curve upwards.
  • Lower consumer burden, higher producer burden.

Perfectly Price Inelastic Supply

• Diagram: Vertical supply curve.
• Process:
  • Supply curve cannot shift.
  • Producer burden = entire burden.
  • No change in equilibrium, no consumer burden.

Conclusion

• Key impacts of indirect taxation depend on elasticity of demand and supply.

• Next Topic: Examination of subsidies.