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Tax Burden and free trade

1. The Incidence of the Tax
Identify and explain the factors that determine who actually bears the burden of a tax increase on a specific good, such as gasoline, cigarettes, or some other product. Use at least two examples in your response. Is the incidence of the tax a consideration when government imposes this tax increase? Why or why not?

2. Trade restrictions have a significant impact upon international trade. Identify and discuss at least two arguments that support trade restrictions and two against trade restrictions. Use at least one example for each argument. Which arguments do you agree with and why?

Solution Preview

1. Who bears a tax is depended on the elasticity of the good. Let me show you in two examples,

Consumers bear taxes,

Consider if there is this drug, which is the only cure for some illness (in this case, the demand is said to be inelastic, meaning that buyers are less responsive to price changes). If gov't levies a tax, what do you think the seller of this drug would do? Clearly, they would increase the price by the amount of taxes right? Because those who need the drug have no alternatives to cure their illness. So consumer bears the full tax.

Consider the next example, where produces bear the taxes.

Say the gov't collects taxes on corn. Do you think an individual farmer can try to increase his price and let the consumers bear his tax? Probably not, because there are so many producers (and we don't expect every producer to all decide to increase prices), the individual farmer's decision will not affect the market price, and he will end up selling nothing if he increases his price. In this case, the producers bear the tax. If a good is elastically demanded (meaning consumer are responsive to price changes), then ...

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