Friday, December 28, 2012

Inelastic Supply of corn

If the supply curve for corn is perfectly vertical, how will an excise tax affect the market price of corn? What about a sales tax?

When I started working this problem, I thought I knew what a sales tax and an excise tax were, but I'm not sure now.  This is how I interpreted this problem.

A excise tax is placed on the seller.  In this case, the supply curve can't shift so the entire tax is placed on the producer.  So if the relevant demand curve is D1, then the price seller will sell the corn at $4, send $1 to the government and keep $3.  The producer is hurt by the tax.  Before the tax, the seller was making $16 in revenue, now she earns $12.

If a sales tax is placed on the consumer, then the demand curve shifts to D2 and the consumer pays $3 plus a $1 tax.  The producer collects $4 and sends a $1 to the government and keeps $3. The producer earns $12 in revenue.  

In either case the seller is hurt by the tax when the supply curve is inelastic.  I now digress.

I found this intelligent answer on Yahoo:

Elasticity is also crucially important in any discussion of welfare distribution, in particular consumer surplus, producer surplus, or government surplus. The concept of elasticity was also an important component of the Singer-Prebisch thesis which is a central argument in dependency theory as it relates to development economics.
As always, a tax redistributes income.  The welfare effects will be unequal.  In the next seven days, we will see first hand how a change in taxes affect behavior when the US walks off the fiscal cliff.

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