PRICE ELASTICITY, TAX INCIDENCE, AND SALES VOLUME: A SIMPLE MODEL
Keywords:price elasticity, taxation, incidence
Most intermediate microeconomics textbooks introduce taxes into the basic market model by using a supply-and-demand diagram, and explaining that the economic incidence of the tax falls most heavily on the group (buyers or sellers) whose behavior is least price-elastic. We extend that presentation by using algebra to relate the tax incidence more explicitly to the measurement of price elasticity. The result is a convenient equation showing that the ratio of tax burdens is exactly the inverse of the ratio of (absolute) price elasticities, along with well-known expressions for each group’s share of the tax burden. Additionally, the model generates the impact factor by which an excise tax reduces the quantity of a good sold. Both hypothetical and empirical examples of price elasticity are provided to illustrate the effects of excise and sales taxes.
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