How does price elasticity of demand influence tax incidence?

• A. When demand is elastic, producers bear most of the tax
• B. When demand is inelastic, consumers bear most of the tax
• C. Elasticity has no effect on tax revenue
• D. Elastic demand leads to higher price pass-through than inelastic

Answer: (B)

Tax incidence depends on how strongly buyers and sellers respond to price changes. When demand is inelastic, buyers don’t reduce their purchases much even as the price rises because of the tax. That means the higher price largely reflects the tax and is paid by consumers, so they bear most of the tax burden while producers’ receipts fall only a little. This is the situation where the tax burden falls on the side that is less price-responsive, which in this case is consumers.

If demand were elastic, buyers would cut back a lot in response to higher prices, making it costly for sellers to raise prices by much. In that scenario, sellers would end up absorbing more of the tax rather than passing it all to buyers. Price pass-through tends to be greater when the other side is less elastic, so the idea that elastic demand automatically leads to higher pass-through isn’t correct. Elastic demand generally means buyers resist price increases, shifting more burden to producers.

So the statement that consumers bear most of the tax when demand is inelastic is the best description of how elasticity shapes tax incidence.