Incidence of Taxation

 Incidence of tax refers to the division of a tax burden between buyers/consumers and sellers/producers. 

 
Tax incidence is closely related to the price elasticity of supply and demand.This relationship is shown by the following diagrams

The product is with a relatively price elastic demand , the supply curve is S, demand curve is D and Price P.  When tax is added, supply curve shifts to S_1, the price rises to P₁. Here  most of the tax burden is borne by sellers/ producers  and it is shown as Pbcd. The  buyers/ consumer's burden is shown by P₁abP .

The product is with a relatively price inelastic demand, the supply curve is S,  demand curve is D and Price P.  When tax is added, supply curve shifts to S₁,the price rises to P₁; the price increase is nearly as great as the amount of the tax. Here the buyers/consumers bear more of the burden of tax  and it is  shown as P₁abP and the burden of sellers/producer is shown by Pbcd .

 The product is with a relatively price elastic supply, the supply curve is S, demand curve is D and Price P.  When tax is added, supply curve shifts to S₁, the price rises to P₁; the price increase is nearly as great as the amount of the tax. The burden of tax is borne by the buyers/consumer is shown as P₁abP; the sellers/ producer's burden  is shown by Pbcd  .

 The product is with a relatively price inelastic supply, the supply curve is S, demand curve is D and Price P.  When tax is added, supply curve shifts to S₁, the price rises to P₁. In this case, sellers/ producers bear most of the burden of  tax and it is shown as Pbcd  and the buyers/ consumers is shown by P₁abP.

It is concluded that, if the product is with price elastic demand or price inelastic supply more  Burden of tax is  on sellers/producers than that of buyers/consumers 

 On the other hand, it the product is with price inelastic demand or price elastic supply more burden of tax is on the buyers/consumers than that of sellers/producers 

 This means that, when demand is more elastic than supply, sellers/producers will bear the burden of the tax  and  when supply is more elastic than demand, the tax burden will be on the buyers/consumers.