Incidence of a Tax

The purpose of most taxes is to raise revenue. The type of tax used must be carefully considered because they affect peoples behavior. In this section we consider the effect of an excise tax on the price and quantity sold of a good. An excise tax is paid when a good is purchased. For the seller it adds to the marginal cost of the good, therefore shifting the supply curve to the left by the amount of the tax. As far as the buyer is concerned it is hidden in the price of the good.

The price elasticity affects how much the price will change once the tax is imposed. If the tax results in a substantial price increase then the burden of the tax falls primarily on the consumer. On the other hand, if the price increase is small or non existent then the seller must bear the burden of the tax.

The total tax revenue received by the governmment is the total area given by the yellow and red boxes. It is calculated by mutiplying the amount of the tax by the new equilibrium quantity.