AP_Krugman_Textbook

module 50 Efficiency and Deadweight Loss 503

Section 9 Behind the Demand Curve: Consumer Choice
levied. But it’s important to note that this 50–50 split between consumers and pro-
ducers is a result of our assumptions in this example. In the real world, the incidence
of an excise tax usually falls unevenly between consumers and producers: one group
bears more of the burden than the other.
What determines how the burden of an excise tax is
allocated between consumers and producers? The an-
swer depends on the shapes of the supply and the demand
curves. More specifically, the incidence of an excise tax depends on the
price elasticity of supply and the price elasticity of demand.We can see this by
looking first at a case in which consumers pay most of an excise tax,
and then at a case in which producers pay most of the tax.

When an Excise Tax Is Paid Mainly by Consumers Fig-
ure 50.8 shows an excise tax that falls mainly on consumers: an excise tax on gasoline,
which we set at $1 per gallon. (There really is a federal excise tax on gasoline, though it
is actually only about $0.18 per gallon in the United States. In addition, states impose
excise taxes between $0.08 and $0.37 per gallon.) According to Figure 50.8, in the ab-
sence of the tax, gasoline would sell for $2 per gallon.

istockphoto

figure 50.8

An Excise Tax Paid Mainly

by Consumers

The relatively steep demand curve here re-

flects a low price elasticity of demand for

gasoline. The relatively flat supply curve re-

flects a high price elasticity of supply. The pre-

tax price of a gallon of gasoline is $2.00, and a

tax of $1.00 per gallon is imposed. The price

paid by consumers rises by $0.95 to $2.95,

reflecting the fact that most of the burden of

the tax falls on consumers. Only a small por-

tion of the tax is borne by producers: the price

they receive falls by only $0.05 to $1.95. D

S

$2.95

2.00

1.95

Price of

gasoline

(per gallon)

0 Quantity of gasoline (gallons)

Tax burden

falls mainly

on consumers.

Excise

tax = $1

per gallon

Two key assumptions are reflected in the shapes of the supply and demand curves in
Figure 50.8. First, the price elasticity of demand for gasoline is assumed to be very low,
so the demand curve is relatively steep. Recall that a low price elasticity of demand
means that the quantity demanded changes little in response to a change in price. Sec-
ond, the price elasticity of supply of gasoline is assumed to be very high, so the supply
curve is relatively flat. A high price elasticity of supply means that the quantity sup-
plied changes a lot in response to a change in price.
We have just learned that an excise tax drives a wedge, equal to the size of the tax, be-
tween the price paid by consumers and the price received by producers. This wedge
drives the price paid by consumers up and the price received by producers down. But as
we can see from Figure 50.8, in this case those two effects are very unequal in size. The
price received by producers falls only slightly, from $2.00 to $1.95, but the price paid by
consumers rises by a lot, from $2.00 to $2.95. This means that consumers bear the
greater share of the tax burden.
This example illustrates another general principle of taxation: When the price elastic-
ity of demand is low and the price elasticity of supply is high, the burden of an excise tax falls