Suppose that left-handed basketballs

are selling for $45.

If the government charges

a $7 per ball tax

most people would think

that consumers will now

have to pay $52

and most people are wrong.

We refer to who is impacted by a tax

as the incidence of a tax.

The incidence shows up

as a change in prices.

Consumers pay higher prices

and producers receive lower prices.

The incidence of tax

is always shared

by these two groups.

First, let's look at those basketballs.

Even if the government

is technically collecting

the $7 tax from consumers,

basketball producers will be forced

to lower their pre-tax price.

Otherwise, consumers

will cut back dramatically on quantity.

So the consumer price rises

but not by the full $7.

Likewise, even if the government

is technically collecting the $7

from the producers

on every basketball

that they produce,

the producers will pass along

some of that tax to the consumers

in the form of higher prices.

So the price received

by the producer falls

but not by the full $7.

If the price the consumers pay

rises a lot say by $5

to a total of $50

and the price the producers receive

falls only slightly

say by $2

down to a total of $43,

then we say

that the consumers bear

most of the incidence of the tax.

Their price changed by more relative

to the original price.

When would that happen?

When demand is relatively inelastic

and supply is relatively elastic.

Recall that inelastic demand

means that consumers are not

very sensitive to a price change.

Therefore, producers are able to pass

along more of the tax to consumers

without losing much quantity.

Likewise,

if the price the consumers pay

rises only a little

say by $1 up to $46

and the price the producers receive

falls by a lot

say by $6 down to $39

then we say that producers

bear most of the incidence of the tax.

Their price change changed

by more relative

to the original price.

When would that happen?

When demand is relatively elastic

and supply is relatively inelastic.

Remember that elastic demand

means the consumers are fairly sensitive

to price change.

So the producers will need to absorb

more of the tax themselves

to keep from losing customers.

So the incidence of the tax

actually has nothing to do

with whether the government

is technically collecting the tax

from producers or consumers.

Either way,

consumers see the prices they pay

rise by the same amount

and producers see the prices

they receive fall by the same amount,

but whose prices move more,

it depends on the relative elasticity's

of supply and demand.

The more elastic you are

the less of the incidence

of the tax you bear.