Question

How does the change in price induced by the tax relate to the nature of competition in the market? Briefly discuss.

Answer 1

When the tax is applied, then price increases, but it relates to the market structure in a way that who shares the burden of tax. Fro example, where there is a monopoly and tax is applied, then consumers have no other alternatives in the market. Hence, more of the tax burden, goes to the consumers. But, in perfect competition, firms are the price takers and demand is perfectly elastic in nature. Then, firm and consumers share the burden of tax, but again it is the consumer whose tax burden is higher than the tax burden on firms. So, it is the market that decides the price elasticity of demand and any party with less elasticity, will pay higher burden of tax and the other party will more elastic supply or demand, will pay less burden of tax.

Further, it is the nature of competition that decides the impact of tax in increasing the price. For example, in perfect competition where the firms can enter and exit, competition is high, then tax makes less contribution in increasing the price. But, in monopoly, the increase in tax is directly passed on to the consumers and shown by the rise in price.