Question

Under which circumstances does the tax burden fall entirely on consumers?

Short answer

In conclusion, the tax burden falls entirely on consumers when the demand for a good is inelastic (Ed < 1) and the supply of the good is elastic (Es > 1). This means consumers are not sensitive to price changes, whereas producers can adjust their production accordingly.

Step-by-step solution

Understanding Tax Incidence

Tax incidence refers to how the burden of a tax is distributed between consumers and producers. In this case, we want to find out under which circumstances the full burden of the tax falls on consumers.

Reviewing Supply and Demand

The law of supply and demand states that the quantity of a good that consumers demand increases as its price decreases, and the quantity of a good that producers supply increases as its price increases. When a tax is implemented, it creates a wedge between the price paid by consumers and the price received by producers.

Analyzing Elasticity

Elasticity measures how sensitive the quantity demanded or supplied is to changes in price. The elasticity of demand is the percentage change in quantity demanded for a given percentage change in price, while the elasticity of supply is the percentage change in quantity supplied for a given percentage change in price. In general, the more elastic the demand (or supply) is, the more responsive it is to changes in price.

Determining the Circumstances

For the tax burden to fall entirely on consumers, the demand must be inelastic (i.e., consumers are not sensitive to price changes) while the supply is elastic (i.e., producers are sensitive to price changes). This means that when a tax is implemented, consumers are willing to pay the higher price for the good, while producers can adjust their production accordingly. In mathematical terms, we can represent the elasticities as follows: - Elasticity of demand (Ed) = \(\frac{Percentage \ change \ in \ quantity \ demanded}{Percentage \ change \ in \ price}\) - Elasticity of supply (Es) = \(\frac{Percentage \ change \ in \ quantity \ supplied}{Percentage \ change \ in \ price}\) For the tax burden to fall entirely on consumers, we require: 1. Ed < 1 (Inelastic demand) 2. Es > 1 (Elastic supply) In conclusion, the tax burden will fall entirely on consumers under the circumstance where the demand for a good is inelastic and the supply of the good is elastic. This implies that consumers are not sensitive to price changes while producers can easily respond to those changes.