Question

A tax on the sale of a good results in (i) a deadweight loss and (ii) the burden of the tax being shared equally between the buyer and the seller. True or false? Explain and illustrate your answers.

Answer 1

Answer :

i) A tax on the sale of a good results in a deadweight loss - TRUE

When a tax is imposed on the sale of a good, it basically creates a wedge between the price that the consumers pay and the price that the sellers receive. Where the consumer pays a higher price than the equilibrium and the sellers receive a lower price than the price in equilibrium. Thus this results in loss in both consumer surplus and producer surplus. Some part of it is then captured by the tax revenue collected by the government but the remaining loss of consumer and producer surplus results in an overall decline in the welfare and is known as the deadweight loss.

ii) A tax on the sale of a good results in the burden of the tax being shared equally between the buyer and the seller - FALSE

The burden of the tax is not shared equally rather the price insensitive group (that is either the buyer or the seller) bears the higher portion of the tax. If the demand curve is less sensitive to price changes (that is less elastic) then the buyers have to bear the higher portion of the tax while if the supply curve is less elastic then the producers have to bear the higher portion of the tax.