Question

1.1.Implementing a binding price floor will cause?

2.The consumer carries the highest tax burden of a sales tax when?

Answer 1

Answer 1.1 Implementing "binding price floor" will result in supply surplus

Background Information

A price floor is a government- or group-imposed minimum price that can be charged from buyers for a product, good, commodity, or service. In order to be effective, price floor must be higher than the equilibrium price. Government uses the technique of price floors (by fiscal policy) to keep certain prices from going too low.

There are many instances when Government implements price floor. Two common price floors are supply management and minimum wage laws Other instances of price floors include regulated US airfares before 1978 and minimum price fixed per-drink for alcohol.

A price floor will only create an effective impact on the market only if it is greater than the free-market equilibrium price.

If the price floor is greater than the equilibrium price, this will lead to supply surplus. As shown in the above diagram, Price floor( higher base price) will lead to a higher quantity supplied.

On the contrary, quantity demand will decrease as few people will be willing to pay the higher price. Consequently, this will also lead to a surplus supply.

Secondly, price floor will also lead to relatively more inefficient market and a lower economic surplus. Economic surplus (total welfare) is the sum of consumer and producer surplus.

Producer surplus can be described as the amount that producers gain by selling at a market price that is higher than the price they would be willing to sell for.
Consumer surplus can be defined as the monetary gain obtained by consumers due to the fact that they are able to purchase a product for a price that is less than the highest that they are willing pay.

An effective price floor will uplift the price of a good, which means that the consumer surplus will decrease. Though the effective price floor will also increase the price for producers, any benefit gained from it will be minimized by decreased sales that is caused by decreased demand from consumers due to the rise in price. This mechanism would lead to a net decrease in total economic surplus, also known as deadweight loss.

Answer 1.2 Consumers bears the highest burden of tax when demand is highly inelastic and supply is higly elastic.

Background Information

Tax is the major source of revenue for the government. Despite the above fact, taxes decrease both supply and demand in the market, because sellers get a lower price for their product and buyers have to pay a relatively higher price. Many times the government tries to divide the burden of the tax. However, in reality, this doesn't happen. Tax incidence depends on the respective elasticities of both supply and demand on the taxed product.

Elasticity and tax incidence
Generally, the burden of a tax falls both on the consumers and producers of the taxed good. Question is who bears how much? This depends on elasticity of demand and elasticity of supply. For ascertaining tax incidence, all that is needed is to analyze the elasticity of demand and supply.
In the case of liquor, the tax burden falls on the most inelastic side of the market. For Instance, If the demand for liquor is more inelastic than supply, consumers bear most of the tax burden. But, if supply of liquor is more inelastic than demand, sellers bear most of the tax burden.
We can understand it in a different way.
When the demand is inelastic, consumers are less responsive to price changes, and the quantity demanded remains relatively constant when the tax rate is increased. In the case of liquor, the demand is inelastic because consumers of liquor are addicted to the product. Consequently, The seller can then pass the tax burden along to consumers by charging higher prices without much of a decline in the equilibrium quantity.
When a tax is introduced in a market with an inelastic supply—such as, for example, beachfront restaurant—sellers do not have any choice. They have to accept lower prices. Taxes do not greatly affect the equilibrium quantity. The tax burden, in this case, is on the sellers.
However, If the supply is elastic the tax burden on the sellers would be much smaller, and the tax would result in selling of much lower quantity instead of lower prices received.