Question

The demand for cabbages is Q = 3,000 − 200P and the supply of cabbages is Q = −500 + 200P. If a $4 tax is levied on the sale of cabbages, who bears the statutory incidence? Who bears the economic incidence of this tax? How is it divided up?

Answer 1

Before tax we have Qd = Qs

3000 - 200P = -500 + 200P

3500 = 400P

P = 8.75

Q = 1250

After tax we have

3000 - 200P = -500 + 200(P - 4)

3000 - 200P = -500 + 200P - 800

4300 = 400P

P = 10.75 (paid by buyers)

P = 6.75 (received by sellers)

Hence, statutory incidence is borne by sellers since tax is imposed on them

But economic tax is borne by both buyers and sellers

Tax incidence on buyers = (10.75 - 8.75) = $2

Tax incidence on sellers = (8.75 - 6.75) = $2

Both buyer and sellers are dividing the tax burden in 50:50 ratio.