Since cigarette demand is usually inelastic, significant improvements in the health of
consumers is probably not the primary outcome of higher excise taxes, although they would
seem to be effective revenue-generating devices. Ironically, although the tax is actually
imposed on suppliers of cigarettes, most of the burden of the tax falls upon consumers.
Figure 7.9 illustrates an inelastic demand for cigarettes, before and after an excise tax.
Elasticity, Microeconomic Policy, and Consumer Theory ‹ 85QuantityPrice $ ST
S 0D 0=TQ 0P 0P 1Q 1Figure 7.9The Role the Supply Curve Plays in the Impact of an Excise Tax
We have seen that the greater the price elasticity of demand, the smaller the portion of the
tax paid by consumers. It is also true that the price elasticity of supply plays a role in deter-
mining how much a tax will cause the price to increase and therefore helps to determine
which group, consumers or producers, pays a higher burden of a tax.
It again helps to see if we look at two extremes: a perfectly elastic supply curve and a
perfectly inelastic supply curve.
A perfectly elastic, or horizontal, supply curve tells us that even a very small change in
the price will cause an infinitely large change in the quantity supplied. A per unit tax T
imposed on suppliers causes this horizontal supply curve to shift upward by the amount of
the tax. In Figure 7.10, you can see that the new equilibrium price is exactly Thigher than
the old price P 0 , so consumers pay the entire burden of the tax. The equilibrium quantity
decreases from Q 0 to Q 1 , and the government collects tax revenue equal to T¥Q 1.
Price $Tax RevenueQuantitySTS 0D 0Q 1 Q 0= $TP 0 +TP 0Figure 7.10