A perfectly inelastic, or vertical, supply curve illustrates the special case where any
change in the price creates absolutely no change in quantity supplied. Figure 7.11 shows
that in this case, the supply curve cannot vertically shift. At the equilibrium quantity Q 0 ,
suppliers would like to charge a higher price than P 0 , but any price above P 0 creates a sur-
plus, and this surplus will clear only at the equilibrium price P 0. Therefore the firms must
pay Tto the government for each of the Q 0 units that are sold and consumers continue to
pay the original price of P 0. In this special case, producers pay the entire burden of the tax
because, after paying the tax, they receive only (P 0 – T) on each unit. The government col-
lects total revenue equal to T¥Q 0.
Table 7.4 summarizes the effects of a higher excise tax and how these depend upon the
price elasticity of supply.Table 7.4INCIDENCE
PRICE OF TAX INCIDENCE
ELASTICITY GOVERNMENT DECREASE IN PAID BY OF TAX PAID
OF SUPPLY REVENUE CONSUMPTION CONSUMERS BY PRODUCERS
Es=• The least The most 100% 0%Es> 1 Falling Sizeable More than 50% Less than 50%
Es< 1 Rising Minimal Less than 50% More than 50%Es= 0 The most Zero 0% 100%By now you are probably wondering, “How can I keep all of this straight?” If we con-
sider the extreme cases of perfectly elastic and perfectly inelastic demand and supply curves,
we can draw some general conclusions.- As the price elasticity of demand falls, and the price elasticity of supply rises, the greater
the consumer’s share of a per unit excise tax. Why? Because this describes a situation
where the consumer response to a higher price is negligible and the producer’s response
is sizable. The group that has the best ability to respond to the higher post-tax price is
going to make out better.
86 á Step 4. Review the Knowledge You Need to Score High
Price $Tax RevenueS 0D 0Q 0P 0P 0 –TQuantityFigure 7.11http://www.ebook3000.com