Question

Suppose the price elasticity of demand ($e_D $) is − 1/5 and the price elasticity of supply ($e_s$ ) is 2/5 . Then, the incidence of a specific (or unit) tax on the firms is equal to

• A. 1/ 3
• B. 2/ 3
• C. 1/ 2
• D. 1/ 4

Answer 1

The Correct Option is A

Tax Incidence on Consumers and Producers 

Step 1: Tax Incidence Formula

The incidence of a tax on producers is given by the formula:

Incidence on consumers = e_D / (e_S + |e_D|)

Step 2: Substituting Given Elasticities

Given:

• e_D = 1/5
• e_S = 2/5

Substituting these values:

Incidence on consumers = (1/5) / (2/5 + 1/5)

= (1/5) / (3/5)

= 1/3

Step 3: Interpretation

• The tax burden on consumers is 1/3.
• The remaining 2/3 of the tax burden falls on producers.

Conclusion

Since the incidence on consumers is only 1/3, the majority of the tax burden falls on producers, while consumers bear only a third of it.