Question

A student makes the following statement:

“If the federal government raises the sales tax on gasoline by $0.25, then the price of gasoline will rise by $0.25. Consumers can’t get by without gasoline, so they have to pay the whole amount of any increase in the sales tax.” Under what circumstances will the student’s statement be true? Illustrate your answer with a graph of the market for gasoline.

Answer 1

Solution:

The burden of tax shared by consumers and producers depends on the elasticity of each of the curves. The entire tax burden falls on consumers when the supply curve is perfectly eastic, and demand curve is not. A perfectly elastic curve would mean that the price of good won't change even with a substantial change in quantity. As the consumers can't get by without gasoline, the quantity demanded of gasoline is not too volatile, and can never be the perfectly elastic. Then, the required circumstance of a perfectly elastic supply curve and not a perfectly elastic demand curve, can be shown in graph of market for gasoline as follows:

So, the tax share of sellers is P - P = $0, and that of buyers is P' - P = $0.25, which is the entire tax rate per gasoline.