Tax Incidence and Elasticity

A tax drives a wedge between the price buyers pay and the price sellers keep, and that wedge has to be split. The split follows a simple rule: the side that can walk away more easily escapes more of the tax, and the side stuck in the market absorbs more of it. Walking away is just elasticity. Inelastic means few good substitutes and few alternatives, so that side keeps buying or selling almost the same quantity even as price moves against them, which means they end up eating most of the tax. Elastic means the opposite: that side can shrink its quantity sharply, so sellers or buyers on that side shift the burden onto the other.

Cigarette smokers pay almost the whole cigarette tax because demand for cigarettes is highly inelastic, nicotine keeps people buying, while supply is comparatively elastic. The elasticity-ratio rule makes this precise: buyer share of a tax equals Es / (Es + Ed), seller share equals Ed / (Es + Ed), both times the total tax. Notice the rule is a ratio of the other side's elasticity, which feels backward until you remember that your share of the burden shrinks only when your own elasticity rises.

This connects directly to deadweight loss, the topic right next to it. The same tax creates more deadweight loss as either curve becomes more elastic, because elasticity measures how much quantity shrinks, and shrinking quantity is exactly what creates the lost trades between buyer and seller. Incidence tells you who pays; deadweight loss tells you how much total value vanishes along the way.