Question

a. Assume the demand for soda (eg., Coke, Pepsi) is inelastic. Explain in writing and with a graph how the imposition of an excise tax on soda will affect the market equilibrium price and quantity exchanged.

b. Who bears the ‘burden’ of this tax? Explain.

c. What is a deadweight loss? In your graph, indicate the deadweight loss associated with taxing soda.

Answer 1

a). The excise tax is a tax on the seller , so when the tax is imposed it will add to the business cost of the seller , the production of the soda becomes more expensive. The firm will cut the production to compensate the increased cost , the producion decreases , this is shown by the leftward shift of the supply curve. The equilibrium price will increase and the quantity will decrease.

b). Since the demand for soda is inelastic , the quantity demanded changes less than proportional to the change in prices, so the consumers will bear most of the tax burden in this case.

c). There is a dead weight loss or social welfare loss associated with the tax, when the tax is imposed on the seller it increases the prices paid by the consumers so the weaker sections of the society might not be able to buy the good. The producres also loose , the tax decreases the price received by the sellers so they receive less profit than before which works as discentive for production.