Friday, March 02, 2007

Elasticity, Pigou Taxes and a gas tax

This post at Marginal Revolution makes an interesting (and little understand) point that a tax on gasoline is likely to fall more on producers than consumers. Why?

The result is a simple application of the theory of tax incidence. The burden of a tax falls on those who can least afford to escape the tax. The world's demand for oil is inelastic but the supply is even more inelastic. What is Saudi Arabia, for example, going to do with its oil except sell it? The oil is already fetching a price well above cost so if there is a world tax on oil that's like a tax on land - Saudi Arabian land to be precise - and a tax on land is born by land owners not by consumers

Perhaps a graph can help us here (note this is something we will be discussing shortly, either before or after test 1)

You can easily understand this concept with words, however. When supply and/or demand is elastic, a change in price has an effect on quantity demanded (supplied) that is greater than the change in the price level (remember from class). If producers have a more inelastic supply curve than the consumers demand curve, they are able to pass on less of the tax onto the consumer because consumers will repond by cutting back on consumption (quantity demanded).
In the case of gasoline, consumers may be inelastic but supply is even more elastic (as is pointed out, what else is Venezuela or Saudi Arabia going to produce).

1 comment:

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