Final answer:
Raising the tax on capital income decreases the equilibrium quantity of capital used by firms because the cost of capital increases, and both firms and lenders split the burden of the tax. The elasticity of demand and supply determines who bears the greater burden and whether the equilibrium quantity significantly declines. Therefore, the correct option is A.
Step-by-step explanation:
Does raising the tax on capital income change the equilibrium quantity of capital used by firms, and who pays the tax? The answer is: a. decreases and firms and lenders split the tax. When a tax is imposed on capital income, it increases the cost of using capital for firms. This change can lead to a substitution effect, where firms might use less capital because it is now more expensive. However, both the firms and the lenders (or capital providers) will share the burden of this tax, depending on the relative elasticity of demand and supply of capital.
Elasticity of demand and supply plays a crucial role in determining how a tax affects the equilibrium quantity and who bears the burden of the tax. When you have a case of inelastic supply in the market – meaning suppliers cannot easily alter the quantity of capital they provide – taxes do not greatly affect the equilibrium quantity; instead, the price that sellers receive for their capital decreases. If the demand for capital is also relatively inelastic, the quantity of capital used does not decrease much. However, if capitalists or lenders have alternatives – a more elastic demand – they might choose to invest their capital elsewhere, reducing the quantity of capital in the taxed market. The burden of the tax thus falls more on those who are less responsive to price changes.
Therefore, the correct response regarding who pays the tax and what happens to the equilibrium quantity of capital is that the equilibrium quantity decreases, and both firms and lenders share the burden of the tax, making option a the accurate answer.