Elasticity and the Incidence of a Tax

The incidence of a tax depends on the responsiveness of buyers and sellers to a change in price. The burden of a tax - it's incidence - tends to fall more heavily on whichever side of the market has the least attractive options elsewhere; less sensitive to price changes. The steepness of the supply and demand curves reflects the degree of responsiveness to a price change. Relatively inelastic demand or supply curves are steeper (more vertical), indicating that they are less responsive to a change in price. Relatively elastic demand or supply curves are flatter (more horizontal), indicating a higher degree of reponsiveness to a change in price. Remember that, though closely related, slope and elasticity are different.

 

How much of the tax is borne by the consumer?

We can calculate the fraction of the tax actually borne by the demander (consumer) by dividing the price elasticity of supply by the sum of the price elasticities of supply and demand:

Es = Price Elasticity of Supply

Ed = Price Elasticity of Demand

Fraction of tax borne by demander             =         Es/(Ed+Es)

 

How much of the tax is borne by the supplier?

Similarly, we can calculate the fraction of the tax borne by the supplier (seller) by dividing the price elasticity of demand by the sum of the price elasticities of supply and demand:

Ed = Price Elasticity of Demand

Es = Price Elasticity of Supply

Fraction of tax borne by supplier                =           Ed/(Ed+Es)

 

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