Suppose that the state increases the tax on cigarettes (a tax paid by the seller). If...

Suppose that the state increases the tax on cigarettes (a tax paid by the seller). If the demand is highly inelastic then what happens in the diagram for supply and demand? Who bears the burden of the tax?

Expert Solution

Since, the tax is paid by the seller, it means that the tax is imposed on the seller. But it does not mean that the burden to pay the tax or incidence of tax will fall on the seller alone. Who will be the burden of tax will be determined by the elasticity of supply and demand of the sellers and buyers respectively.

As can be seen in the diagram below an increase in the tax by the government leads to a leftward shift in the supply curve. Since the demand curve is highly inelastic a greater part of the tax is paid by the consumers and very small fraction of tax is actually paid by the sellers. So here, the consumers bear most of burden of tax.

Rahul Sunny answered 2 years ago

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