A state is considering legalizing the sale of cannabidiol as a dietary supplement, but taxing it. If the supply of cannabidiol is more elastic than the demand for it, which group bear most of the incidence of the tax?
A consumers
B producers
C the state government
D the federal government
The correct answer and explanation is:
The correct answer is B) producers.
When a tax is imposed on a good or service, the tax burden is divided between consumers and producers depending on the elasticity of supply and demand. If the supply of cannabidiol is more elastic than the demand for it, this means that producers are more responsive to changes in price than consumers are. In this case, producers are more likely to adjust their production or pricing strategies in response to the tax.
Here’s why:
- Elastic supply means that producers can easily increase or decrease the quantity they supply in response to price changes. This flexibility allows producers to adjust their production more efficiently if the price decreases due to the tax.
- Inelastic demand means that consumers are less sensitive to price changes. Even if the price of cannabidiol increases because of the tax, consumers may still buy relatively consistent quantities because they value the product and cannot easily switch to alternatives.
As a result, the producers will likely bear a larger share of the tax burden. They will absorb part of the tax increase by reducing their prices to keep consumer demand stable, rather than passing on the full cost of the tax to consumers. On the other hand, because demand is inelastic, consumers will still purchase the product, even if the price increases, but they will not bear as much of the tax burden as producers.
In summary, because producers have more flexibility in adjusting to price changes (due to elastic supply), they tend to bear a larger share of the tax burden when demand is inelastic.