Question

Suppose the government imposes a tax on three products with differing demand elasticities. Match the product to the group that will most likely bear the incidence of the tax.

1) Product A: Inelastic demand
2) Product B: Elastic demand
3) Product C: Unitary elastic demand
4) Cannot be determined

Answer 1

The tax burden of a product depends on the elasticity of its demand. Consumers bear the most tax on products with inelastic demand, while producers bear the most on those with elastic demand. For products with unitary elastic demand, the tax burden is more evenly split.

Step-by-step explanation:

Understanding the concept of elasticity and tax incidence helps us determine who will bear the burden of a tax on products with differing demand elasticities. If we apply this to three products:

• Product A with inelastic demand: Since consumers are less sensitive to price changes, they will continue to purchase nearly the same amount regardless of the tax, meaning they will likely bear most of the tax burden.
• Product B with elastic demand: Here, consumers are highly sensitive to price changes and may greatly reduce their purchases if the product's price rises due to the tax. Thus, producers will likely have to bear most of the tax burden to keep the price from rising too much and losing customers.
• Product C with unitary elastic demand: For products with unitary elasticity, the tax burden could be shared more equally between consumers and producers, since the percentage change in quantity demanded is approximately the same as the percentage change in price. However, the exact split would depend on other market dynamics.

Therefore, the match would be:

1. Inelastic demand - Consumers bear most of the tax burden.
2. Elastic demand - Producers bear most of the tax burden.
3. Unitary elastic demand - The burden is shared, making it harder to determine with certainty who bears most of the burden without additional information.