Question

- The impact of tax on markets and welfare distribution. - Use supply and demand diagrams to answer the following questions. Draw
new diagrams for answers to each part.
a- Show that regardless of who the tax is levied on (consumers or producers), a tax
increase the price paid by consumers, decrease the price received by producers, and make
the market smaller compared with a free market. Notes: You should use two diagrams, one for
tax on consumers and one for tax on producers.
b- Show that regardless of who the tax is levied on (consumers or producers) the burden of
tax will be shared between consumers and producers
c- Show that the burden of tax falls more heavily on relatively more inelastic side of the
market.
d- Show that the greater the elasticity of supply and demand, the greater the deadweight
loss of a tax.
e- Show that the greater the elasticity of supply and demand, the smaller the tax revenue
generated by a given tax.
f- Show that, fixing elasticity of supply and demand, the impact of an increase in tax rate on
tax revenue depends on whether the initial tax rate is “too low” or “too high”.
g- Show that the relatively more elastic side of the market benefits relatively less from a
given tax cut.

Answer 1

(a)

Regardless of the imposition of tax on producers or consumers, the price paid by buyers is P' and price received by sellers is P".

(b)

Green shaded region shows tax share of buyer and yellow shades region shows tax share of producers.

(c)

From above diagram, we can see that demand is relatively inelastic as compared to supply. So the buyers have to pay more share of tax.

It can be seen that green shaded region is more than yellow shaded region.

(d)