Multiple Choice
When the government passes a new tax on fast food that takes effect immediately, what is most likely to happen to the equilibrium price and quantity in the fast food market?
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6. Introduction to Taxes and Subsidies
Introducing Taxes and Tax Incidence
Multiple Choice
Which of the following statements concerning taxation is accurate?
A
The economic burden of a tax always falls entirely on the party that is legally responsible for paying it.
B
A tax imposed on sellers will not affect buyers in any way.
C
If demand is perfectly elastic, consumers bear the entire burden of the tax.
D
The incidence of a tax depends on the relative elasticities of supply and demand.
Verified step by step guidance1
Understand the concept of tax incidence, which refers to how the burden of a tax is divided between buyers and sellers, regardless of who is legally responsible for paying the tax.
Recall that the economic burden of a tax depends on the relative price elasticities of demand and supply, not just on the legal assignment of the tax.
Analyze the effect of a tax on sellers: even if sellers are legally responsible for the tax, the price they receive may decrease, causing some of the tax burden to be passed on to buyers through higher prices.
Consider the case of perfectly elastic demand: if demand is perfectly elastic, buyers will not tolerate any price increase, so sellers bear the entire tax burden, not consumers.
Conclude that the correct statement is that the incidence of a tax depends on the relative elasticities of supply and demand, as this determines how the tax burden is shared between buyers and sellers.
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