Final answer:
With highly inelastic demand, consumers bear the majority of the tax burden, as they are less sensitive to price increases and do not significantly reduce their quantity demanded. Producers bear a smaller portion of the tax incidence, and the government may collect significant tax revenues because the quantity sold does not decrease much.
Step-by-step explanation:
When considering the incidence of an excise tax on a product or service, it is crucial to understand how elasticity affects the division of the tax burden between producers and consumers. In the case where demand is highly inelastic, consumers are less responsive to price changes, meaning that quantity demanded doesn't decrease significantly when the price increases. Therefore, the tax incidence falls more heavily on consumers.
Referring to Figure 5.10, when an excise tax is imposed, there is a difference between the price consumers pay (Pc) and the price producers receive (Pp). The initial equilibrium price (Pe) is disrupted by the tax. In scenario (b), where the supply is more elastic than demand, the tax incidence on consumers (Pc - Pe) is larger compared to the incidence on producers (Pe - Pp). With highly inelastic demand, consumers tend to absorb most of the tax burden because they continue purchasing nearly the same quantity despite higher prices.
The concept also implies that tax revenue generated from a market with highly inelastic demand could be significant because consumers do not greatly reduce their quantity purchased despite the higher price after the tax imposement. On the contrary, in markets with more elastic demand, consumers would likely reduce consumption in response to higher prices, leading to lower tax revenues.