Chapter 18: Problem 14
If supply is perfectly inelastic, a tax increase is bome (L.O7) a) only by the buyer b) only by the seller c) mostly by the buyer d) mostly by the seller
Short Answer
Expert verified
The correct answer is (b) only by the seller. In the case of a perfectly inelastic supply, the sellers cannot change the quantity they supply, and therefore, they bear the burden of an increased tax.
Step by step solution
01
Understand the Concept of Perfectly Inelastic Supply
Perfectly inelastic supply means that the quantity supplied by the seller does not change, no matter the price. In this case, the supply curve is a vertical line.
02
Understand the Concept of Tax Impact
In most cases, when a tax is introduced or increased, the burden is divided among buyers and sellers depending on the elasticity of demand and supply. The side of the market that is less elastic ends up bearing most of the tax burden.
03
Apply the Concept
Recognize that because supply is perfectly inelastic, the sellers cannot change the quantity they supply and therefore cannot escape from the burden of the tax. Therefore, an increased tax, in this case, is borne by the sellers. This means that option (b) only by the seller, is the correct answer.
04
Confirm answer
To further confirm this, one could draw a graph with the quantity on the x-axis and the price on the y-axis, mark the tax as a vertical line representing the perfectly inelastic supply, and show how taxes are absorbed by the suppliers rather than being passed on to buyers. This would visually confirm answer (b) as the correct response.
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Key Concepts
These are the key concepts you need to understand to accurately answer the question.
Perfectly Inelastic Supply
When we talk about a perfectly inelastic supply, we are describing a situation where the quantity supplied does not change regardless of changes in price. This is represented graphically by a vertical supply curve.
This happens because the suppliers are unable or unwilling to alter the quantity they produce or sell even if the market price increases or decreases.
This happens because the suppliers are unable or unwilling to alter the quantity they produce or sell even if the market price increases or decreases.
- For instance, consider a scenario where there is only a limited amount of a resource, like rare minerals. No matter how high the demand might rise, the supply can't go beyond what is available.
- In another example, certain specialized medical equipment might be produced at a fixed rate regardless of price changes due to technological or resource constraints.
Supply and Demand
Supply and demand form the backbone of economic theory, representing the relationship between the quantity of a commodity that producers wish to sell and the quantity that consumers wish to buy.
The supply curve typically slopes upward because as prices increase, producers are willing to supply more of the good. Conversely, the demand curve generally slopes downward because higher prices lead to reduced consumer demand.
The supply curve typically slopes upward because as prices increase, producers are willing to supply more of the good. Conversely, the demand curve generally slopes downward because higher prices lead to reduced consumer demand.
- Equilibrium in this model occurs where the supply and demand curves intersect, determining the market price and quantity.
- When taxes are introduced, they can shift these curves depending on which side incurs more of the tax burden.
Tax Burden
The term "tax burden" refers to who ultimately pays the tax. Depending on the elasticity of supply and demand, the tax burden can shift between buyers and sellers.
A tax burden is heavier on the side of the market that is less elastic. If supply is perfectly inelastic, as previously discussed, sellers bear the full tax burden since they must sell a fixed quantity regardless of price.
A tax burden is heavier on the side of the market that is less elastic. If supply is perfectly inelastic, as previously discussed, sellers bear the full tax burden since they must sell a fixed quantity regardless of price.
- On the other hand, if demand is perfectly inelastic, buyers would bear the tax since their purchase quantity doesn't change despite the price change.
- This concept helps policymakers understand the consequences of tax policies on different market participants.
Market Elasticity
Market elasticity measures how much the quantity demanded or supplied responds to changes in price. It shows the flexibility of consumers and producers in adjusting to price changes.
If a market is elastic, even small price changes can lead to significant changes in quantity demanded or supplied. On the other hand, an inelastic market shows minimal change in quantity in response to price changes.
If a market is elastic, even small price changes can lead to significant changes in quantity demanded or supplied. On the other hand, an inelastic market shows minimal change in quantity in response to price changes.
- Elasticity of demand can vary significantly between products. Luxury goods typically have high elasticity, whereas necessities show lower elasticity.
- For supply, elasticity depends on how quickly production levels can adjust and how resources are allocated.