Question

Under what elasticity conditions will producers of a product be able to pass all of an excise tax to consumers? Explain.

Suppose the demand for Rick’s Revolvers is price-inelastic. If Rick wants to increase his revenues from the sale of his revolvers, should he raise or should he lower his price? Explain.

Answer 1

Part 1:

The burden of a tax falls on the producers and consumers on the basis of the elasticity of demand and supply. A producer can pass all of an excise tax to consumers when the price elasticity of demand the good is perfectly inelastic. In this case, any change in price would not affect the quantity demanded by the consumers. So, the producer can pass the entire tax to the consumers.

Part 2:
In the case demand is inelastic, the % change in quantity demand is lower than the % change in price. Therefore, in the case of inelastic demand, increasing the price increases revenue. This happens because the % fall in quantity demanded would be lower than the % increase in price. So, revenue would increase by increasing price. Therefore, Rick should increase the price to increase revenue.