Consider the following statements : 1. Burden of a tax on a commodity is independent of who (buyer or seller) it is explicitly imposed upon 2. Burden of a tax on a commodity depends on the slope of the demand and supply curves Which of the statements given above is/are correct?

Correct — C, Both 1 and 2. Statement 1 is the equivalence result at the heart of tax incidence. Whether the law collects a commodity tax from the seller or from the buyer changes only the label on the cheque: if the tax is put on sellers the supply curve shifts up by the tax, if it is put on buyers the demand curve shifts down by the tax, and either way the wedge between the price the buyer pays and the price the seller keeps is the same, so the division of the burden is unchanged. Statement 2 says what does decide the division. The burden falls more heavily on whichever side is less responsive to price, which is read off the slopes, or more precisely the elasticities, of the two curves. A steep demand curve against a flat supply curve leaves consumers carrying most of the tax; the reverse leaves producers carrying it.

• (a)1 only — It accepts the equivalence result but denies that the slopes matter, which leaves the division of the burden unexplained. If neither the statute nor the curves decided it, nothing would.
• (b)2 only — It rejects the equivalence result, which is the more surprising of the two and the reason economists distinguish statutory incidence from economic incidence. Where the law places the levy does not decide who ends up paying.
• (d)Neither 1 nor 2 — Both propositions are standard results in price theory, and they fit together: the first says the statute does not matter, the second says what does.

Statutory incidence is who the law requires to pay a tax. Economic incidence is who actually bears it once prices adjust. For a tax of t on a commodity, the equilibrium quantity falls and a wedge of exactly t opens between the buyer's price and the seller's price, no matter which side is legally liable. The share borne by consumers rises as demand becomes less elastic relative to supply, which is why taxes on cigarettes, fuel and salt land largely on consumers.

The item rewards a candidate who has drawn the diagram rather than memorised a definition. Shifting the supply curve up by the tax and shifting the demand curve down by the tax produce the same new quantity and the same pair of prices, and once that is seen statement 1 stops being counter-intuitive. The limiting cases are worth carrying: perfectly inelastic demand means consumers bear the whole tax, and perfectly elastic demand means producers bear all of it.

• Statutory incidence is the legal liability; economic incidence is where the burden settles after prices adjust.
• A commodity tax opens a wedge equal to the tax between the buyer's price and the seller's price, whichever side is liable.
• The side of the market that is less elastic bears the larger share of the burden.
• With perfectly inelastic demand the consumer bears the entire tax; with perfectly elastic demand the producer does.
• The reduction in quantity traded is what generates the deadweight loss of the tax.

• Assuming that a tax collected from producers is borne by producers.
• Confusing the impact of a tax, which is on the person who pays it first, with its incidence.
• Treating a steeper curve as more elastic; a steeper demand curve is less elastic over the relevant range.

A two-statement microeconomics item, one statement stating the equivalence result and the other stating what actually decides the split.

• practice — not a real PYQ

  A commodity tax will be borne almost entirely by consumers when

  • (a)Demand is perfectly elastic
  • (b)Demand is perfectly inelastic
  • (c)Supply is perfectly inelastic
  • (d)Both curves have the same slope

  Answer(b) Demand is perfectly inelastic — buyers do not reduce purchases, so the whole tax is passed on in price.

• practice — not a real PYQ

  The difference between the price paid by the buyer and the price received by the seller after a commodity tax is imposed equals

  • (a)Half the tax
  • (b)The tax
  • (c)The tax multiplied by the elasticity of demand
  • (d)Zero

  Answer(b) The tax — the wedge is exactly the size of the levy, whoever is legally liable for it.