How Taxes on Buyers Affect Market Outcomes

We first consider a tax levied on buyers of a good. Suppose for instance that our local government passes a law requiring buyers of ice-cream cones to send 0.50 to the government for each ice-cream cone they buy. How does this law affect the buyers and sellers of ice cream? To answer this question we can follow the for analyzing supply and demand. We decide whether the law affects the supply curve or demand curve. We decide which way the curve shifts. We examine how the shift affects the equilibrium.

The initial impact of the tax is on the demand for ice cream. The supply curve is not affected because for any given price of ice cream sellers have the have the same incentive to provide ice cream to the market. By contrast buyers now have to pay a tax to the government ( as well as the price to the sellers) whenever they buy ice cream. Thus the tax shifts the demand curve for ice cream.

We next determine the direction of the shift. Because the tax on buyers makes buying ice cream less attractive buyers demand a smaller quantity of ice cream at every price. As a result the demand curve shifts to the or equivalently downward.

Having determined how the demand curve shifts we can now see the effect of the tax by comparing the equilibrium and the new equilibrium. You can see in the figure that the equilibrium price of ice cream falls from and the equilibrium quantity from. Because sellers sell less and buyers buy less in the new equilibrium the tax on ice cream reduces the size of the ice-cream market.

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