A. How can a tax on commodity be shifted forwards and backwards?
B. What determines the amount of forward shifting that will occur?
A. A tax on a commodity can be shifted both forwards and backwards. When a tax is shifted forward, it means that the burden of the tax is passed on to the consumers of the commodity, causing the price of the commodity to increase. On the other hand, when a tax is shifted backward, the burden is absorbed by the producers of the commodity, resulting in reduced profits for them.
To understand how the shifting occurs, let's consider the example of a tax on a specific good, such as cigarettes. Initially, when the tax is imposed, the burden falls on the producer or seller of the cigarettes. However, they may not be able to bear the entire burden of the tax without affecting their profits. To offset their increased costs, they might choose to raise the price of the cigarettes. This increase in price is how the tax is shifted forward to the consumers. As a result, the consumers end up paying a higher price for the product, and the burden of the tax is indirectly transferred to them.
B. The amount of forward shifting that occurs depends on several factors, including the price elasticity of demand and supply for the commodity, the competitiveness of the market, and the availability of substitutes.
1. Price elasticity of demand: If the demand for the commodity is relatively inelastic, meaning that consumers are not very responsive to changes in price, the producers can pass on a significant portion of the tax to the consumers. In an inelastic market, consumers are less likely to reduce their consumption significantly due to price increases, allowing producers to increase prices without losing a large number of customers.
2. Price elasticity of supply: If the supply of the commodity is highly elastic, meaning that producers can easily increase production in response to price increases, it becomes more challenging to shift the tax forward. In a competitive market with elastic supply, producers may absorb a larger portion of the tax burden to avoid losing market share to competitors.
3. Market competitiveness: In a highly competitive market, where many producers offer similar products, it becomes more difficult for individual producers to shift the tax forward. In such cases, producers may have to absorb a larger portion of the tax to remain competitive and prevent customers from switching to alternative brands or products.
4. Availability of substitutes: If there are readily available substitutes for the commodity, consumers have the option to switch to those substitutes if the price of the taxed commodity increases too much. In such a scenario, producers may have limited ability to shift the tax forward, as consumers can easily opt for cheaper alternatives.
To determine the amount of forward shifting that will occur, it is crucial to consider these factors and analyze the specific market conditions in which the commodity is being traded.