Question

As part of a get-fit program, the government imposes an excise tax on high-fat fast foods. If both demand and supply are inelastic, which of the following outcomes is likely to occur in terms of tax incidence?

A) Consumers bear most of the tax burden
B) Producers bear most of the tax burden
C) The burden is equally shared between consumers and producers
D) The tax burden is entirely borne by the government

Answer 1

When both demand and supply are inelastic, the tax incidence falls on both consumers and producers, with the more inelastic side bearing a greater burden. Without specifics on relative inelasticity, one cannot determine the exact split of the tax burden between consumers and producers.

Step-by-step explanation:

When the government imposes an excise tax on high-fat fast foods and both demand and supply are inelastic, the tax incidence tends to fall on the side of the market that is more inelastic. Since both demand and supply are mentioned as inelastic, we would predict that the tax burden is less responsive to price changes on both sides. However, if we cannot determine which one is more inelastic than the other, we may conclude that the burden of the tax will probably be shared between consumers and producers, although not necessarily equally.

Real-world examples, like cigarette taxes, show that when a product has an inelastic demand, a tax on it does not significantly reduce the equilibrium quantity of the good consumed, and the higher prices resulting from the tax are mostly absorbed by consumers. Therefore, in the case of high-fat fast foods with both an inelastic demand and supply, consumers are likely to bear a significant portion of the tax, but without more information on the relative inelasticity, an exact split cannot be determined.