If the market demand for a good is inelastic and the supply is elastic, which of the following is true when there is an increase in sales tax?

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BlackTom AI · Accepted Answer

To tackle this question, I’ll walk through each answer choice and explain the logic behind why it is or isn’t correct, given inelastic demand and elastic supply with a sales tax increase.
Option 1: 'Both consumers and producers will share the burden of the tax equally.' This would imply a roughly 50/50 tax incidence, which occurs only if the elasticities of demand and supply are similar. Since demand is inelastic and supply is elastic, the burden does not split equally; the more inelastic side bears more of the burden. Therefore this statement is incorrect.
Option 2: 'Producers will bear most of the burden of the tax or risk losing sales.' With elastic supply, producers can adjust quantities and largely avoid bearing the tax; they can reduce quantity and pass costs to consumers when possible. In contrast, because demand is inelastic, consumers are less responsive to price changes and end up absorbing more of the tax. So this option misidentifies the burden distribution and is false.
Option 3: 'The price of the good will not change.' A tax on a good typically shifts the supply curve upward by the tax amount, leading to a higher price for buyers and/or a lower price received by sellers. In this scenario, with inelastic demand, consumers’ price increases more noticeably, so claiming no price change is incorrect.
Option 4: 'Consumers will bear most of the burden of the tax.' This aligns with standard incidence analysis: when demand is inelastic relative to supply, consumers bear a larger share of the tax burden because their quantity demanded doesn’t drop much in response to price increases. The tax reduces consumer welfare more than producer welfare in this case, making this statement correct.
Option 5: 'Producers will bear all of the burden of the tax.' Incidence is never completely on the producer when demand is inelastic but not perfectly inelastic and supply is elastic; producers cannot shoulder the entire burden in typical market conditions. This overstates the producer burden and is therefore incorrect.
In summary, the key insight is that the tax burden falls more heavily on the side of the market that is less responsive to price changes. Since demand is inelastic and supply is elastic, consumers end up bearing the larger share of the tax, which makes Option 4 the correct choice. The other options misstate how elasticity affects tax incidence and the resulting price changes.

AP Economics-Hillebrand AP Microeconomics Sem 1 Exam 2025 - Requires Respondus LockDown Browser

If the market demand for a good is inelastic and the supply is elastic, which of the following is true when there is an increase in sales tax?

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AP Economics-Hillebrand AP Microeconomics Sem 1 Exam 2025 - Requires Respondus LockDown Browser

If the market demand for a good is inelastic and the supply is elastic, which of the following is true when there is an increase in sales tax?

View Explanation

Log in for full answers

Similar Questions

After the government imposed a $0.20 per gallon tax on gasoline, the price of a gallon of gasoline increased from $1.00 to $1.15. Which of the following statements is true?

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