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This diagram illustrates the effect of taxation on a market with perfectly inelastic supply and elastic demand. Source self-made, based on work by User:SilverStar on Image:Deadweight-loss-price-ceiling.svg. Date 2008-03-17 Author Explodicle Permission (Reusing this file) See below.
Perfectly inelastic demand is represented by a vertical demand curve. Under perfect price inelasticity of demand, the price has no effect on the quantity demanded. The demand for the good remains the same regardless of how low or high the price. Goods with (nearly) perfectly inelastic demand are typically goods with no substitutes. For instance ...
When the demand curve is perfectly inelastic (vertical demand curve), all taxes are borne by the consumer. When the demand curve is perfectly elastic (horizontal demand curve), all taxes are borne by the supplier. If the demand curve is more elastic, the supplier bears a larger share of the cost increase or tax. [16]
If demand changes by less than the change in price or income, it has inelastic demand. Economists use elasticity of demand to gauge how responsive consumers are to changes in price and income, but ...
If demand is unitary elastic, the quantity falls by exactly the percentage that the price rises. Two important special cases are perfectly elastic demand (= ∞), where even a small rise in price reduces the quantity demanded to zero; and perfectly inelastic demand (= 0), where a rise in price leaves the quantity unchanged.
This diagram illustrates the maximum taxation rate on a product with a perfectly inelastic supply. Source self-made, based on work by User:SilverStar on Image:Deadweight-loss-price-ceiling.svg. Date 2009-06-25 Author Explodicle (T/C) Permission (Reusing this file) See below.
In other words, when the supply curve is more elastic, the area between the supply and demand curves is larger. Similarly, when the demand curve is relatively inelastic, deadweight loss from the tax is smaller, comparing to more elastic demand curve. A tax results in deadweight loss as it causes buyers and sellers to change their behaviour.
If price elasticity of demand is calculated to be less than 1, the good is said to be inelastic. An inelastic good will respond less than proportionally to a change in price; for example, a price increase of 40% that results in a decrease in demand of 10%. Goods that are inelastic often have at least one of the following characteristics: