This is to help Tx and any others understand who pays a tax. The answer almost always is that both producers and consumers end up with some of the burden. "Common sense" would say that the cost of the tax is passed along to the consumer and partially, that is true. However, to an economist, the overall burden is not just the money collected by a tax. The burden also includes the loss to society of production that a tax imposes on producers.
That's where "common sense" goes off the rails. The full accounting to society of a tax that has been imposed includes more than just the revenue raised.
Begin by understanding what a demand schedule is. This is a line showing how much of a good is demanded by a consumer at a given price. As the price changes, the quantity demanded changes. For a normal good, this is an inverse relationship - as price increases, quantity demanded decreases and vice versa. The graph of this relationship is a negatively sloped line.
A supply schedule shows what suppliers are willing to supply at various price points. For a normal good, this would be a positively sloped line since a higher price would result in more of that good being supplied to the market.
Next, we need to understand the concept of price elasticity. This is defined as the responsiveness of either production or consumption with respect to price changes. For both of these groups, a good can be either price elastic or price inelastic.
"Elastic" means that a given percentage change in price leads to a greater percentage change in either consumption or production. For example, price elasticity in consumption might be seen in meat consumption. As the price of beef rises, people move their consumption into lesser grades meat or substitute chicken for beef. If this was graphed out with price on the independent x axis and consumption on the dependent y axis, it would be a fairly low sloped negatively sloped line, higher on the left side and lower on the right.
Please refer to the following links as I trot you through this:
https://www.economicshelp.org/microe...ticity-demand/
https://www.economicshelp.org/microe...ticity-supply/
Price inelasticity of demand looks different. In this case, larger percentage changes in price are met with less responsiveness by demand. This is a more vertical line.
Price elasticity of supply measures responsiveness of producers to a price change. An elastic supply means that producers are highly responsive to changes in price. This would be a positively sloped line at a shallow angle. If producers are relatively unresponsive to changes in price, this would be a steeply sloped positive line.
The effect of a tax is different for consumers and producers. A tax is merely a change in price to a consumer, so their demand schedule is unchanged and we merely move to a new price/consumption point on the existing demand schedule.
The effect of a tax on a producer is much different. Look towards the bottom of the first link I provided. In the case of a producer, a whole new supply schedule is needed since he or she finds that the cost of production is now higher at every quantity produced. This means that their supply schedule shifts to a new supply schedule (a whole new line showing price/quantity relationships). The shift is inward toward the price axis, showing that for each price, less quantity is supplied due to the overall increased cost of production.
As you can see at the link I've provided, the relative burden of a tax consists of two parts - the cost of the tax in monetary terms and the loss to society of production that the newer supply schedule imposes.
Common sense would tell you that only consumers bear the burden of the tax. This is not true. The total accounting for the burden of the tax consists of the monetary part and the loss of production that a now artificially higher cost of production imposes on producers. The relative price elasticities of demand and supply show how much of the burden of the tax falls on producers and consumers. But for almost all goods, the burden will be shared.
The problem with "common sense" is that people don't know enough about a topic to be able to understand that the topic is more complex than they, with their superficial knowledge, realize. They don't know how much they don't know.4. Tax incidence. If demand is price inelastic, then a higher tax will lead to higher prices for consumers (e.g. tobacco tax). The tax incidence will mainly be borne by consumers. If demand is price elastic, firms will face a bigger burden, and consumers will have a lower tax burden.
So they end up looking foolish.
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Originally Posted by Kevin
