Question

1. Explain why the allocation of the tax burden does not depend on who pays a tax to the government?
2. Do the economic effects of a tariff depend on who pays it? Why or why not?
3. What are some ways that companies can reduce the currency risk they face?
4. What is the advantage of equity financing over debt financing?

Answer 1

Key points

• Tax incidence is the manner within which the tax burden is split between consumers and sellers.
• The tax incidence depends on the relative worth physical property of offer and demand. once offer is a lot of elastic than demand, consumers bear most of the tax burden. once the demand is a lot of elastic than the offer, producers bear most of the price of the tax.
• Tax revenue is larger the lot of nonresilient the demand and provides square measure.

The burden of tax

Depending on the circumstance, the burden of the tax will fall a lot of on shoppers or on producers.
In the case of cigarettes, for instance, demand is inelastic—because cigarettes square measure associate habit-forming substance—and taxes square measure chiefly passed on to shoppers within the style of higher costs.
The analysis, or manner, of however the burden of a tax is split between shoppers and producers is named tax incidence.

Elasticity and tax incidence

Typically, the incidence, or burden, of a tax falls each on the shoppers and producers of the taxed smart. however, if we wish to predict that cluster can bear most of the burden, all we'd like to try and do is examine the physical property of demand and provide.
In the tobacco example on top of, the tax burden falls on the foremost nonresilient facet of the market. If demand is a lot of nonresilient than the offer, shoppers bear most of the tax burden. But, if the offer is a lot of nonresilient than demand, sellers bear most of the tax burden.
Think about it this way—when the demand is nonresilient, shoppers don't seem to be terribly tuned in to worth changes, and therefore the amount demanded remains comparatively constant once the tax is introduced. within the case of smoking, the demand is nonresilient as a result of shoppers square measure passionate about the merchandise. the vendor will then pass the tax burden on to shoppers within the style of higher costs while not a lot of a decline within the equilibrium amount.
When a tax is introduced {in a|during a|in associate exceedingly|in a very} market with a nonresilient supply—such as, for instance, land hotels—sellers haven't any alternative however to simply accept lower costs for his or her business. Taxes don't greatly have an effect on the equilibrium amount. The tax burden during this case is on the sellers. If the availability were elastic and sellers had the chance of reorganizing their businesses to avoid supply the taxed smart, the tax burden on the sellers would be a lot of smaller, and therefore the tax would end in a far lower amount sold rather than lower costs received. you'll be able to see the link between tax incidence and physical property of demand and provide described diagrammatically below.

In diagram A, on top of on the left, the availability is nonresilient, and therefore the demand is elastic—as it had been within the land hotels example. whereas shoppers might produce other vacation decisions, sellers can’t simply move their businesses. By introducing a tax, the govt primarily creates a wedge between the value paid by shoppers, the text starts a text, P, c, end text, and therefore the worth received by producers, text start a text, P, p, end text. In different words, of the full worth paid by shoppers, half is preserved by the sellers, and half is paid to the govt within the style of a tax. the gap between text starts to text, P, c, finish text and text start a text, P, p, finish text is that the rate. The new value is text start a text, P, c, end text, however, sellers receive solely text start a text, P, p, finish text per unit sold since they pay text-text−Ppstart text, P, c, end text, minus, start a text, P, p, finish text to the govt. Since a tax is viewed as raising the prices of production, this might even be described by a leftward shift of the availability curve. The new offer curve would intercept the demand at the new amount text start a text, Q, t, end text. For simplicity, the diagram on top of omits the shift within the offer curve.
The taxation is given by the shaded space, that is obtained by multiplying the tax per unit by the full amount sold, text start text, Q, t, end text. The tax incidence on the shoppers is given by the distinction between the value paid, the text starts a text, P, c, end text, and therefore the initial equilibrium worth, text start a text, P, e, end text. The tax incidence on the sellers is given by the distinction between the initial equilibrium worth, the text starts a text, P, e, end text, and therefore the worth they receive once the tax is introduced, text start a text, P, p, end text.

In diagram A, on top of on the left, the tax burden falls disproportionately on the sellers, and a bigger proportion of the tax revenue—the shaded area—is because of the ensuing cheaper price received by the sellers than by the ensuing higher costs paid by the consumers.
On the opposite hand, if we have a tendency to return to our example of butt taxes, things would look a lot of like diagram B—above on the right—where the availability is a lot of elastic than demand. The tax incidence currently falls disproportionately on shoppers, as shown by the massive distinction between the value they pay, the text starts a text, P, c, end text, and therefore the initial equilibrium worth, the text starts a text, P, e, end text. Sellers receive a cheaper price than before the tax, however, this distinction is way smaller than the modification in consumers’ worth.

Using this sort of study, we will additionally predict whether or not a tax is probably going to form an outsized revenue or not. A lot of elastic the demand curve, the better it's for customers to scale back amount rather than paying higher costs. A lot of elastic the provision curve, the better it's for sellers to scale back the amount sold rather than taking lower costs. in a {very} market wherever each the demand and provide ar very elastic, the imposition of AN indirect tax generates low revenue.

People typically suppose that excise taxes hurt principally the particular industries they aim. however ultimately, whether or not the tax burden falls totally on the trade or on the customers depends merely on the snap of demand and provide.