Elasticity and the incidence of taxes and subsidies

Overview

Incidence of a tax, specific tax and ad valorem tax.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What is meant by the incidence of a tax?

   Model answer

   The incidence of a tax is the share of the tax burden actually borne by each party. Consumers and producers share the burden of an indirect tax between them.

2. 2

   What is a specific tax?

   Model answer

   A specific tax is a fixed amount charged on each unit sold. The supply curve shifts upward in parallel by the amount of the tax.

3. 3

   What is an ad valorem tax?

   Model answer

   An ad valorem tax is charged as a percentage of the price. The supply curve pivots upward, so the money gap widens as price rises.

4. 4

   A specific tax of £2 per unit raises the market price from £10 to £11.50. State the incidence on each party.

   Model answer

   Consumers bear £1.50 of the £2 tax through the higher price. Producers bear the remaining £0.50 out of the price they receive.

5. 5

   Who bears most of a tax when demand is price inelastic?

   Model answer

   Consumers bear most of the tax when demand is price inelastic. Buyers keep purchasing despite the higher price, so producers can pass the tax on.

6. 6

   Who bears most of a tax when demand is price elastic?

   Model answer

   Producers bear most of the tax when demand is price elastic. Sales would fall sharply if the full tax were added to the price.

Other ways to work this

The same content, four other ways.

What is inside Levo

Six ways to work the same material.