13.7 : Incidence of Tax I

Inelastic demand refers to a situation where the quantity demanded of a good changes minimally in response to price fluctuations. Goods with inelastic demand, such as essential commodities like rice, exhibit this behavior because consumers prioritize these goods regardless of price changes. In economic terms, the demand curve for these goods is steep, reflecting minimal sensitivity to price.

When a tax is imposed on a good with inelastic demand, such as rice, the supply curve shifts leftward due to the higher costs producers face. Since consumers' demand for rice remains relatively unchanged despite price increases, the new equilibrium results in a higher market price but only a small decrease in quantity. This disproportionate price increase places most of the tax burden on consumers, significantly reducing their consumer surplus—the difference between what consumers are willing to pay and what they pay.

Producers of inelastic goods tend to experience minimal losses from the tax. Since demand for their product is price-insensitive, they can pass most of the tax burden onto consumers through higher prices. This allows producers to maintain their producer surplus—the benefit they gain from selling goods above their minimum acceptable price. As a result, producers experience limited reductions in profitability even with the tax in place.

Although demand remains relatively stable, the tax creates deadweight loss, representing the market's inefficiency. Some consumers may reduce their rice consumption or reallocate their spending to other goods. Deadweight loss emerges from these missed transactions, as both consumers and producers lose potential benefits from exchanges that would have occurred without the tax.