haya.Learning made clear
Tax incidence, consumer surplus and producer surplus sheet
Essay frame

Explain how the burden of an indirect tax is distributed between consumers and producers, and its effect on consumer and producer surplus.

How to lay out the answer. Follow the frame, then write it in your own words.

  1. 1 · Define the terms. Indirect tax, impact and incidence of a tax.
  2. 2 · Draw the tax diagram. [Diagram: D, S and S + tax; buyers' price, sellers' price, the tax wedge, the two burden rectangles and the deadweight loss triangle]
  3. 3 · State the elasticity rule. Consumer share = Es ÷ (Es + |Ed|); the less elastic side pays more.
  4. 4 · Show the cases.
    • Inelastic demand: consumers pay most
    • Elastic demand: producers pay most
    • Perfectly inelastic demand: consumers pay all
  5. 5 · Numerical example. Rs. 25 tax: P rises 150 → 165, sellers keep 140; consumers 60%, producers 40%; revenue Rs. 67,500.
  6. 6 · Effect on surplus. CS falls 225,000 → 182,250; PS falls 150,000 → 121,500; deadweight loss Rs. 3,750.
  7. 7 · Sri Lankan business link. Excise taxes on cigarettes, liquor and fuel fall mainly on consumers because demand is inelastic.
  8. 8 · Conclude. Who legally pays a tax does not decide who bears it; elasticities do.

Scoring tip: Shade the consumer and producer burden areas in different ways on the diagram and label them.