Chapter 18: Problem 13

When demand is perfectly elastic, a tax increase is bornc (L.O7) a) only by the buyer c) mostly by the buyer b) only by the seller d) mostly by the seller

Short Answer

Expert verified

In a market with perfectly elastic demand, any tax increase cannot be passed on to the buyers, as they are unwilling to pay a higher price. Therefore, the burden of the tax increase falls entirely on the seller, not on the buyer. The correct answer is (b) only by the seller.

Step by step solution

Understanding the Concept of Perfectly Elastic Demand

Perfectly elastic demand refers to a market scenario where the quantity demanded by consumers responds to an infinite extent to any change in price. In other words, consumers would buy as much of a product as possible at a certain price but if the price were to increase, even by a very small amount, the quantity demanded would drop to zero. This can be visualised as a horizontal demand curve on a price-quantity graph.

Impact of a Tax Increase on the Seller and Buyer

When a tax is imposed, it increases the price of goods or services. If a seller tries to pass on this extra cost to the buyers by increasing the price of the product, in a scenario of perfectly elastic demand, the buyers would stop purchasing that product or service. This means the seller cannot pass on the tax burden to the buyers.

Who Bears the Tax Burden?

Given that the demand is perfectly elastic, and buyers are not willing to pay a higher price, it would mean that any tax increase cannot be passed on to the buyers. Therefore, the burden of the tax increase falls entirely on the seller, not on the buyer. So, the correct answer is (b) only by the seller.

Understanding the Implication

This scenario suggests that in a market with perfectly elastic demand, a seller must absorb any additional costs from a tax increase to maintain sales. The firm might have to look at reducing costs elsewhere to remain profitable.

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