AS & A-Level Economics — Market Intervention and Redistribution

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Original Deckloop economics study material on market intervention and redistribution, with 90 practice cards and 18 concept explainers. Includes worked applications and analytical reasoning.

Economics EN A-Level

90 cards

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Tax Incidence and Elasticities

Tax incidence refers to the distribution of the burden of a tax between consumers and producers, irrespective of who is legally responsible for paying it (statutory incidence). The economic incidence of a tax is determined by the relative price elasticities of demand (PED) and supply (PES). The side of the market that is relatively more inelastic will bear a greater proportion of the tax burden. If demand is more inelastic than supply, consumers bear more of the tax. Conversely, if supply is more inelastic than demand, producers bear a larger share. This is because the more inelastic side has fewer alternatives and is less responsive to price changes, making it harder for them to avoid the tax.

Key points

Tax incidence is the actual distribution of the tax burden, not who legally pays it.
It is determined by the relative price elasticities of demand and supply.
The more inelastic side of the market bears a greater share of the tax burden.
If PED is more inelastic than PES, consumers bear more; if PES is more inelastic than PED, producers bear more.

Worked example

Question

In the market for a specialised medical device, the price elasticity of demand (PED) is estimated to be -0.4, and the price elasticity of supply (PES) is +2.0. If a specific tax is introduced on this device, which group, consumers or producers, will bear the larger share of the tax burden? Explain your reasoning.

Solution

1. Identify the given elasticities: PED = -0.4 (absolute value is 0.4), PES = +2.0.
2. Compare the absolute values of PED and PES: 0.4 (demand) is less than 2.0 (supply).
3. Conclude which side is relatively more inelastic: Demand is significantly more inelastic than supply.
4. Apply the principle of tax incidence: The more inelastic side bears a greater proportion of the tax burden.
5. Therefore, consumers, facing a relatively inelastic demand, will bear the larger share of the tax burden.

Consumers will bear the larger share of the tax burden. This is because the absolute value of the price elasticity of demand (0.4) is significantly lower than the price elasticity of supply (2.0), indicating that consumers are less responsive to price changes and have fewer alternatives compared to producers.

Common pitfalls

Confusing statutory incidence with economic incidence: The legal requirement to pay a tax (statutory incidence) does not determine who ultimately bears the economic burden. For example, if producers are taxed, they can often pass part of it to consumers.
Inferring elasticity from the slope of the demand/supply curve alone: While slope is related, elasticity is a measure of proportional responsiveness. Incidence depends on relative elasticities, not just the visual steepness of the curves, especially when comparing different points or scales.

Prerequisites

Deck 04 — Specific Taxes and the Price Wedge: To understand what a specific tax is and how it creates a price wedge, which is the burden whose distribution is explained by tax incidence.
Deck 03 — Elasticity Categories and Limiting Cases: To understand the concept and categories of price elasticity of demand, which determines consumers' responsiveness to price changes and their share of the tax burden.
Deck 03 — Elastic and Inelastic Supply: To understand the concept and categories of price elasticity of supply, which determines producers' responsiveness to price changes and their share of the tax burden.