Suppose the market for grass seed can be expressed as Demand: QD = 100

Suppose the market for grass seed can be expressed as Demand: QD = 100 – 2p Supply: QS = 3p Price elasticity of supply is constant at 1. If the demand curve is changed to Q = 10 – .2p, price elasticity of demand at any given price is the same as before. Yet, the incidence of a tax falling on consumers will be higher. Why?

What will be an ideal response?

ANSWER

With the same vertical intercept, the steeper demand curve results in the equilibrium price being lower than with the old demand curve. At the lower price, demand is relatively less elastic than with the original curve. Since the incidence of a specific tax on consumers is n/(n – e), where n is the price elasticity of supply and e is the price elasticity of demand, therefore when e increases (less elastic demand), the incidence on consumers will be higher.