Answer to Question #161782 in Macroeconomics for Selena

Question

1. What effect does a $1 specific tax have on equilibrium price and quantity, and what is the incidence on consumers, if
2. The demand curve is perfectly inelastic?
3. The demand curve is perfectly elastic? 
4. The supply curve is perfectly inelastic?
5. The supply curve is perfectly elastic?

Use graphs and math to explain your answers. 

Answer 1

1) Let's consider the effect of $1 specific tax if the demand curve is perfectly inelastic.

The good example of the perfectly inelastic demand is the lifesaving drug (insulin) that people will pay any price to obtain. Imposition of the specific tax will cause the shift of the supply curve to the left. The equilibrium quantity remains unchanged, but the price of the dose of the insuline will rise by the amount of tax and the consumers will pay all the tax. The incidence on consumers equals $(P_{E2}-P_{E1})Q_E$.

2) Let's consider the effect of $1 specific tax if the demand curve is perfectly elastic.

Let's consider the market for coffee. If the price of the cup of coffee will increase due to imposition of the tax, the consumers might decide to buy tea instead of coffee. Then, the supply curve will shift to the left. The equilibrium quantity will fall, but the equilibrium price will remain unchanged. In this case, the producers will pay all the tax.

3) Let's consider the effect of $1 specific tax if the supply curve is perfectly inelastic.

Let's consider the market for spring water. If the government imposes $1 specific tax per bottle, then the demand curve will shift to the left, equilibrium price will fall and the equilibrium quantity will remain unchanged. In this case, the producers will pay all the tax.

4) Let's consider the effect of $1 specific tax if the supply curve is perfectly elastic.

Let's consider the market for sand. If the government imposes $1 specific tax per pound of sand, then the demand curve will shift to the left, the equilibrium quantity will fall but the equilibrium price will remain unchanged. In this case, he consumers will pay all the tax. The incidence on consumers equals $(P_{C}-P_{E})Q_{E2}$.