2004 Economics Past paper MC

Question

Suppose the government imposes a per unit sales tax on the good X of which the supply is perfectly inelastic. Only_________ will bear the tax burden, and the quantity transacted will__________.

A. sellers...remain unchanged
B. sellers...decrease
C. buyers...remain unchanged
D. buyers...decrease

The answer is A. Why?????????????????????????

Answer 1

As you know, a perfectly inelastic supply curve implies the Qs will remain the same at any price level. So the imposition of a per unit sales tax WILL NOT affect the Qs and supply curve. Some students may misunderstand the supply curve will shift to the left, which is conceptually wrong for a perfectly inelastic supply curve.

For example,
before the per unit tax:
Market price = $10/unit
Quantity transacted = 100 units (where Qd=Qs)
The total revenue received by the sellers was $1,000 ($10x100 units)

If the government imposes $2 per unit tax then....,
Market price will STILL be $10 as the supply will not shift at all!
Quantity transacted will STILL be 100 units as the supply curve is perfectly inelastic.
However, the AFTER TAX total revenue received by the seller will reduce from $1,000 to
($10-$2)x100 units = $800.

So you can see in this example that only the sellers will bear the tax burden ($2 x 100)=$200 and the Qs will remain unchanged.

Hope the explanation is clearly enough. Not easy to explain thoroughly without the illustration of diagrams....