Question

How much of a tax gets passed along to consumers depends on the relative steepness of the demand and supply curves. If the supply curve is horizontal, all of the tax gets passed along to consumers; if the supply curve is vertical, none of the tax gets passed along.

Short answer

Horizontal supply curve: tax is fully passed to consumers; vertical supply curve: no tax is passed to consumers.

Step-by-step solution

Understand Supply Curve Dynamics

A horizontal supply curve implies perfectly elastic supply. This means suppliers can supply any amount of goods at a fixed price. Hence, any tax imposed would result in a price increase equivalent to the tax amount because suppliers cannot absorb the tax without losing all their sales.

Analyze the Horizontal Supply Curve

With a horizontal supply curve, the introduction of a tax increases the cost of production. The price consumers pay will fully reflect this tax increase, as producers are unwilling or unable to absorb any of the cost due to the perfectly elastic nature of the supply.

Understand the Vertical Supply Curve

A vertical supply curve indicates perfectly inelastic supply. Here, the quantity supplied is constant regardless of price. Hence, any taxes will not be passed to consumers in terms of higher prices; instead, the producers absorb the entire tax amount because they cannot change the quantity produced.

Analyze the Vertical Supply Curve

In the case of a vertical supply curve, since the quantity cannot adjust and consumers will pay the same price regardless, no tax is passed on to consumers. Producers will bear the full tax burden.

Key concepts

Supply Curve

The supply curve in economics shows the relationship between the price of a good or service and the amount that producers are willing and able to supply. It is typically upward sloping, meaning that as prices increase, producers are willing to supply more as they are incentivized by higher profits. However, the shape of the supply curve can also vary significantly:

- **Horizontal Supply Curve**: This represents a perfectly elastic supply. Producers will supply any quantity at a fixed price. If a tax is introduced, the entire tax gets passed to consumers since producers cannot absorb the cost without losing all sales.
- **Vertical Supply Curve**: This indicates a perfectly inelastic supply. Quantity supplied remains constant regardless of price changes. In this case, producers absorb the full tax burden because they cannot alter production levels in response to price changes.

Elasticity

Elasticity measures the responsiveness of the quantity supplied or demanded to a change in price. It can apply to both supply and demand:

- **Price Elasticity of Supply**: It indicates how much the quantity supplied changes in response to a change in price. A horizontal supply curve has infinite elasticity, meaning the slightest change in price leads to an infinite change in quantity supplied. In contrast, a vertical supply curve has zero elasticity, indicating no change in quantity supplied despite price changes.
- **Price Elasticity of Demand**: Similar in concept, it measures how demand responds to price changes. High elasticity implies consumers will change their purchasing levels significantly with price changes, while low elasticity indicates little change in demand despite price fluctuations.

Understanding elasticity is crucial as it influences how the burden of taxes is distributed between consumers and producers.

Consumer Burden

The consumer burden refers to the portion of a tax that consumers effectively pay through higher prices. How much of a tax burden consumers bear depends on the elasticity of demand and supply.

- **High Elasticity of Supply (Horizontal curve)**: Consumers tend to bear most if not all of the tax burden, as producers pass the entire tax onto the consumers in the form of higher prices.
- **Low Elasticity of Supply**: Consumers may bear less of the tax burden, as producers can absorb some of the tax by adjusting production.

The way the tax burden is split between consumers and producers will depend largely on how flexible each group is to changes in price.

Producer Burden

The producer burden represents the share of tax that producers absorb. This scenario depends highly on the elasticity of the supply and the demand curves:

- **Perfectly Inelastic Supply (Vertical curve)**: Producers bear the total tax burden since they are unable to adjust the quantity produced, and cannot pass the tax onto consumers.
- **Inelastic Demand**: If demand is inelastic, producers might still face a significant part of the tax burden even if the supply is not completely inelastic. This is because consumers do not significantly reduce their quantity demanded despite price increases.

The interplay between the supply and demand elasticities ensures that understanding the producer's burden is essential when examining the economic implications of a tax.