of Tshifts the supply curve upward by T, but with a perfectly elastic demand curve, the
equilibrium price of cigarettes does not change, while equilibrium quantity demanded falls
to Q 1. Total spending by consumers falls to the area P 0 ¥Q 1. Tax revenue for the govern-
ment is a much smaller rectangle T¥Q 1.
Who paid for the tax in this case? Because the price of a pack of cigarettes did not
increase after the tax, it was not the consumers. Each producer receives a price of P 0 but must
then pay Tto the government, so the net price received from each pack of cigarettes is
(P 0 – T). So the producer pays the entire share of the tax when demand is perfectly elastic.
Compared to the perfectly inelastic scenario, the government collected much fewer tax rev-
enue dollars, but the maximum decrease in harmful cigarette consumption is a definite plus.
With these two extreme cases as benchmarks, we can conclude that as demand is more
inelastic, consumers pay a higher share of an excise tax. Government revenues from the
excise tax increase with inelastic demand, but the goal of decreasing consumption sees only
minimal success. Table 7.3 summarizes the effects of a higher excise tax and how these
depend upon the price elasticity of demand.Table 7.3INCIDENCE
PRICE OF TAX INCIDENCE
ELASTICITY GOVERNMENT DECREASE IN PAID BY OF TAX PAID
OF DEMAND REVENUE CONSUMPTION CONSUMERS BY SUPPLIERS
Ed=• The least The most 0% 100%Ed > 1 Falling Sizeable Less than 50% More than 50%
Ed < 1 Rising Minimal More than 50% Less than 50%Ed= 0 The most Zero 100% 0%84 á Step 4. Review the Knowledge You Need to Score High
QuantityPrice $
ST
S 0D 0=TQ 0P 0P 0 +T
RevenueFigure 7.7QuantityPrice $ STS 0D 0=TQ 0P 0P 0 - TRevenueQ 1Figure 7.8TIPhttp://www.ebook3000.com