Suppose supply is perfectly inelastic, while demand is relatively elastic. A tax of $1.00 is levied on the purchasers of the good. Which of the following statements is correct?

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BlackTom AI · Accepted Answer

Consider the scenario: supply is perfectly inelastic, meaning quantity supplied does not respond to price changes, while demand is relatively elastic, so quantity demanded can change a lot with price.

Option a: 'there will be no deadweight loss' — This is correct in this specific case because with perfectly inelastic supply, the quantity traded is fixed regardless of the price buyers pay. A tax on purchasers shifts the price paid by buyers up by the tax amount, but since Q is fixed, there is no reduction in traded quantity. Deadweight loss arises when the quantity traded falls below the pre-tax equilibrium, but here that does not happen. Therefore, DWL is zero and government revenue collects the tax burden transferred from buyers to the government/sellers depending on incidence, without creating a welfare loss from decreased quantity.

Option b: 'there will be a positive deadweight loss' — This would be true if the tax caused a reduction in the quantity traded. However, with perfectly inelastic supply, quantity does not decrease when the price changes due to the tax, so DWL does not arise. The elasticity of demand does not translate into a quantity reduction because supply fixes the quantity.

Option c: 'government revenue will be less than the deadweight loss of the tax.' — Since we established there is no deadweight loss (DWL = 0) in this scenario, the comparison 'revenue < DWL' cannot hold. Government revenue would be equal to the tax per unit times the number of units traded, and DWL is zero, so this statement is false.

Option d: 'the government will fail to raise any tax revenue' — In this setup, the tax is imposed on purchasers and, despite the fixed quantity, the price paid by buyers increases by the tax amount, so the government does collect revenue equal to tax rate times quantity. Therefore this statement is incorrect.

In summary, option a is consistent with the standard tax incidence outcome when supply is perfectly inelastic: quantity is unchanged, there is no deadweight loss, and the tax burden is shifted between buyers, sellers, and the government without reducing traded quantity. The other options misstate the implications by implying DWL arises, denying revenue collection, or mischaracterizing incidence given the perfect inelasticity of supply.

ECX2953 - ECX5953 - S2 2025 ECX2953-ECX5953 Mid-Semester Test - 20%

Suppose supply is perfectly inelastic, while demand is relatively elastic. A tax of $1.00 is levied on the purchasers of the good. Which of the following statements is correct?

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