I have a example of supply and demand. If there is a regulation that requires customers to pay additional tax when they purchase cigarettes, would supply or demand curve shift? I know that tax/subsidies is one of supply's non-price determinants, however, it is only applicable to producers. I doubt that this example is concerned with demand curve. Nevertheless, tax is not one of demand non-price determinants. Thanks!

  • $\begingroup$ I just want to note that, in your example, customers are required to pay the additional tax. It is possible to have the supplier pay the tax, in which case the answer may be different. $\endgroup$
    – majmun
    Commented Jan 7, 2016 at 20:16
  • $\begingroup$ When you say "customers have to pay the additional tax", you mean that they have to go to a state agency and actually pay it themselves? Or they give the money to the supplier which then has to hand it over to the state? $\endgroup$ Commented Jan 7, 2016 at 21:06

3 Answers 3


As stated by @Wecon, the demand curve will shift down.

It is two different things to determine which curve will shift and who will actually bear the burden of the tax.

To answer the later problem, we need to look at price-elasticity of supply and of demand. The most inelastic (that is, the curve the most vertical) will bear the higher weight of the tax.

Here is an example with a fairly elastic supply curve, and a rather inelastic demand curve (forgive my drawing skills).

enter image description here

The demand curve, because of the tax $t$; shifts from $D$ to $D'$. The consumers will now pay price $P$, while producers will receive $P' = P - t$.

The variation of the surplus of each agents is quite telling : in ugly-rose, we can see that the consumers, who have an inelastic demand, loose a lot, actually most of the total loss of surplus. In the opposite, the purple area represents the producer's loss of surplus, which is smaller than the consumer's.

If the supply is inelastic and the demand elastic, than the roles are reverse, the producers ending up bearing a heavier part of the tax.

If the tax is imposed on the suppliers, then the prices will be the same: the consumers will still pay $P$ and the suppliers will pay the tax, thus receiving $P'$

In short: no matter to whom you impose the tax, the elasticity allocate its burden to the agents. The economic incidence of the tax and its legal incidence are distinct concepts.

  • $\begingroup$ This is not correct. The existence of a tax component in the price does not affect the demand curve, which won't shift, since it already reflects consumer preferences for any price level, no matter what are the components of the price. In the (very rare) case where a final consumer has to pay personally a tax directly to the state (and not give the tax amount to the seller who will give it to the state), what happens is that the two sides of the market face different prices, which is a tricky situation to draw and reason upon. $\endgroup$ Commented Jan 7, 2016 at 21:21
  • $\begingroup$ The only way when one could picture the demand curve as shifting down, is to put price before tax (or "seller price") on the vertical axis. Only then one could picture the situation as a downward demand shift. $\endgroup$ Commented Jan 7, 2016 at 21:24
  • $\begingroup$ I understand, this makes sense. Then, the only change in the curves because of taxes come from us looking at the problem from the perspective of the supplier or the consumer, isn't it? Looking from the equilibrium point of vue, the curves stay the same, but the new equilibrium is no more at the intersect of the two curve, but is located at the intersect of the curves with a vertical line at quantity $Q$ such that $D_Q = S_Q + t$. $\endgroup$
    – Hector
    Commented Jan 7, 2016 at 21:33
  • $\begingroup$ Yes, eventually. Initially, it will be at a lower quantity, because at the new quantity demanded immediately after the imposition of the tax, suppliers would be willing to charge a lower price before tax, than before. Assuming no barriers to entry or capacity constraints, competition will drive the price before tax down increasing quantity demanded, up until the point you mention (this assumes that the tax is a fixed amount and not a percentage mark-up on the price before tax). $\endgroup$ Commented Jan 7, 2016 at 22:58
  • $\begingroup$ The demand curve, as people usually graph it, will shift down. This is because we are graphing market demand and market price, and the tax is not a part of the market price. However, depending on your definition of "demand curve" or what you are graphing, it may not shift down. I doubt the original question is about such a case, though. $\endgroup$
    – majmun
    Commented Jan 7, 2016 at 23:51

In partial equilibrium, demand shifts down, with the (vertical) distance between the pre-tax and post-tax curve being exactly the height of the tax.

pre-tax curve: $q=f(p)$

post-tax curve: $q=f(p+t)$

  • 1
    $\begingroup$ This is actually only true in a partial equilibrium setting! OP made no indication that we are assuming a partial equilibrium where all other markets are held fixed. In a general equilibrium setting, both supply and demand can shift, and even shift in unexpected ways, since income effects may dominate. $\endgroup$
    – HRSE
    Commented Jan 8, 2016 at 3:09
  • $\begingroup$ That is indeed a valuable point of criticism. I add this nuance in my answer. $\endgroup$
    – Wecon
    Commented Jan 8, 2016 at 7:21

It depends on how competitive the taxed product is and its cost of production. In some cases, the seller can not pass the entire tax onto the consumer and the seller have to swallow some of the tax by lowering prices. This would be common in monopolistic industries with low variable costs as their prices tend to be already maxed and can not go higher (such that the volume lost would not offset the higher markups).

Take oil for example. Say gas sells for 10 dollars a gallon in state A and state B which are next to each other. State B adds a gas tax of 1 dollar per gallon. If stations in state B charge 11 dollars a gallon than customers will go to State A to fill up. This forces state B stations to lower the price and eat the cost of the tax. In such a scenario this has not really affected the demand curve.

  • $\begingroup$ Note that, at least for your example, if the tax was imposed on every seller in the industry (say a national tax on gas), then demand would still decrease (unless a perfectly inelastic good is taxed). $\endgroup$
    – majmun
    Commented Jan 7, 2016 at 20:14

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