Chapter 5: Problem 30

In a market where the supply curve is perfectly inelastic, how does an excise tax affect the price paid by consumers and the quantity bought and sold?

Short Answer

Expert verified

In a market with a perfectly inelastic supply curve, introducing an excise tax will cause the supply curve to shift upwards by the amount of the tax. Consequently, the price paid by consumers increases by the full amount of the excise tax, as producers do not absorb any of the tax burden. However, the quantity bought and sold in the market remains unchanged, as it is not influenced by the price level.

Step by step solution

Understand the concept of a perfectly inelastic supply curve

A perfectly inelastic supply curve is a vertical line on a supply and demand graph, which represents that the quantity supplied does not change regardless of the price. In other words, producers are willing to supply a fixed amount of goods or services, no matter what the market price is.

Understand the concept of an excise tax

An excise tax is a tax levied on the production or sale of a specific good or service. It can be considered as a cost for producers and shifts the supply curve upward by the amount of the tax.

Analyze the effect of an excise tax on the perfectly inelastic supply curve

In the case of a perfectly inelastic supply curve, when an excise tax is introduced, the supply curve will remain vertical but will shift upwards by the amount of the tax. The quantity supplied will not change, as it is not influenced by price.

Determine the effect on the price paid by consumers

As the supply curve shifts upwards after the introduction of the excise tax, the new equilibrium point will be at a higher price level. This means that the price paid by consumers will increase by the full amount of the excise tax, as the producers do not absorb any of the tax burden due to the perfectly inelastic nature of the supply curve.

Determine the effect on the quantity bought and sold

In the case of a perfectly inelastic supply curve, the quantity supplied is not affected by the price level. Thus, even with the introduction of an excise tax and the subsequent increase in the price paid by consumers, the quantity bought and sold in the market will remain the same as it was before the tax was introduced. In conclusion: 1. The price paid by consumers will increase by the full amount of the excise tax. 2. The quantity bought and sold in the market will remain unchanged.