Economics – Consumer and producer surplus | e-Consult

Diagram and Impact of a Tax:

A tax on a good shifts the supply curve upwards. The new supply curve is parallel to the original but higher. This leads to a new equilibrium with a higher price and a lower quantity traded. The magnitude of the change in price and quantity depends on the relative elasticities of demand and supply.

Influence of PED and PES:

• Elastic Demand & Inelastic Supply: If demand is elastic and supply is inelastic, the tax will lead to a relatively large change in quantity and a relatively small change in price. Consumers are highly responsive to price changes, so they will significantly reduce their consumption in response to the tax. Producers have limited ability to adjust their output in response to the tax, so the burden of the tax falls primarily on consumers.
• Inelastic Demand & Elastic Supply: If demand is inelastic and supply is elastic, the tax will lead to a relatively small change in quantity and a relatively large change in price. Consumers are not very responsive to price changes, so their consumption will not decrease significantly. Producers have a lot of flexibility to adjust their output in response to the tax, so they can absorb much of the tax burden.
• Elastic Demand & Elastic Supply: If both demand and supply are elastic, the tax will lead to a relatively small change in both price and quantity. Both consumers and producers are highly responsive to price changes, so the burden of the tax is shared between them.

The price elasticity of demand and supply determine how the tax burden is distributed between consumers and producers, and the overall impact on the equilibrium price and quantity.