The incidence of a tax refers to who eventually pays a tax. An indirect tax on producers increases their costs and this will lead to an inward shift of the supply curve. Once the tax is imposed, suppliers may then chose to pass on the tax to consumers by raising their selling price. This depends on the coefficient of price elasticity of demand. When demand is inelastic (i.e. Ped<1), then most of the tax can be passed on. This is because consumers are less sensitive to price changes, e.g. a 20% increase in price might only lead to a 5% contraction in demand. However, when demand is price elastic (i.e. Ped>1), then most of the incidence of a tax is absorbed by the producer. In this situation, only a small proportion of the tax will be paid by the consumer. The incidence of an indirect tax also depends on the coefficient of price elasticity of supply. When supply is perfectly elastic (i.e. Pes= infinity) this means that output can be supplied at constant cost. A tax on producers again causes an inward shift of the supply curve. But in this situation, all of the tax will be paid by the consumer, regardless of the coefficient of PED. When demand is elastic, the consumer pays all of the tax, but equilibrium quantity will contract by a large amount.

2. Explain how the incidence of a tax depends on the price
elasticity of demand and the price elasticity of supply

3. Explain how the incidence of a tax depends on the price
elasticity of demand and the price elasticity of supply

4. Explain how the incidence of a tax depends on the price
elasticity of demand and the price elasticity of supply
However, when demand is price elastic (i.e. Ped>1), then most of the incidence of a tax is absorbed by the producer.
In this situation, only a small proportion of the tax will be paid by the consumer.
When demand is inelastic (i.e. Ped<1), then most of the tax can be passed on. This is because consumers are less
sensitive to price changes, e.g. a 20% increase in price might only lead to a 5% contraction in demand.
Once the tax is imposed, suppliers may then chose to pass on the tax to consumers by raising their selling price. This
depends on the coefficient of price elasticity of demand.
The incidence of a tax refers to who eventually pays a tax. An indirect tax on producers increases their costs and this
will lead to an inward shift of the supply curve.

5. Price
P2
Demand
P1
Q1
S1
S1 + tax
Price
Total tax
paid by the
consumer
Perfectly Inelastic Demand
All of the tax is paid by the consumer
Quantity

6. Explain how the incidence of a tax depends on the price
elasticity of demand and the price elasticity of supply
When demand is elastic, the consumer pays all of the tax, but equilibrium quantity will contract by a large amount
But in this situation, all of the tax will be paid by the consumer, regardless of the coefficient of PED
A tax on producers again causes an inward shift of the supply curve
When supply is perfectly elastic (i.e. Pes= infinity) this means that output can be supplied at constant cost
The incidence of an indirect tax also depends on the coefficient of price elasticity of supply.

7. Price
Demand
S1
S1 + tax
Q1Q2
P2
P1
Perfectly Elastic Supply
All of the tax is paid by the consumer
Tax Per Unit
To ensure that suppliers
receive the required minimum
price after an indirect tax, the
market price must rise by the
full amount of the tax.
Quantity