Draw a supply and demand graph for gasoline. Consider whether supply or demand for gasoline is...

Draw a supply and demand graph for gasoline. Consider whether supply or demand for gasoline is more inelastic, and draw the curves accordingly. Label the original equilibrium price $3. In California, the federal, state and local excise and sales taxes total about 77 cents per gallon. Assuming the government taxes the seller directly, draw the impact of this tax on the supply and demand diagram. Label the new price the consumer pays (Pc), the price the seller receives after taxes (Ps), and the tax revenue received by the government. Does the consumer or the seller bear more of the burden of this tax? Explain.

Solutions

Expert Solution

In following graph, D0 & S0 are initial demand and supply curves for gasoline. Since demand is less elastic (gasoline having less substitutes in short run), demnd curve is steeper than supply curve. Initial equilibrium is at point A with price P0 (= $3) and quantity Q0. After a tax is imposed on sellers, effective price received by sellers falls by $0.77 for every output level, which lowers supply and shifts supply curve leftward to S1, intersecting D0 at point B. Price paid by consumers is higher at Pc, price received by sellers is Ps, (Pc - Ps) being unit tax (= $0.77) and quantity is lower at Q1. Tax revenue equals area PcBCPs.

Tax burden of buyers = Pc - P0

Tax burden of sellers = P0 - Ps

Since (Pc - P0) > (P0 - Ps), buyers bear a higher tax incidence. This is due to the fact that demand is more inelastic than supply curve.

Rahul Sunny answered 2 years ago

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