Tax Incidence

Tax incidence is the question of who economically bears a tax — which can differ sharply from who legally pays it. For a per-unit tax $t$ on a monopolist with linear demand $P = A - bQ$ and constant $MC = c$, equilibrium price rises by $t/2$ and quantity falls by $t/(2b)$: consumers and the monopolist split the burden 50/50. With Constant Elasticity Demand the split shifts according to elasticity — the less elastic side bears more of the tax. A Lump-Sum Tax, by contrast, does not affect $MR$ or $MC$, so it leaves $P^*$ and $Q^*$ unchanged: the producer absorbs the full incidence.

When to use

Compute incidence whenever an exam question asks who really pays a tax, or compares the welfare effects of alternative tax instruments. The default decomposition for any per-unit tax: $\Delta P = \text{pass-through fraction} \times t$, and the consumer's share is exactly that fraction. The key contrasts to memorise: per-unit tax shifts $MC$ up by $t$ (price rises, quantity falls); lump-sum tax shifts profit down by the lump sum (no quantity effect); a tax on profits leaves everything unchanged because it scales the objective uniformly.