In the Village of Punjab, Sheryl owns a well, which is the only source of drinking water. The supply of water is perfectly inelastic at a quantity of 1,000 gallons of water per day

Question

At a price of $2.00 per gallon, the quantity demanded per day is 1,000 gallons. The government imposes a $0.50 per gallon tax.
a) After the tax is imposed, what is the price paid by the villagers? What is the price received by Sheryl?
b) How much revenue does the government collect?
c) What fraction of the tax does Sheryl pay? What fraction is paid by the villagers?

Answer 1

a) Because the supply is perfectly inelastic, no matter what price Sheryl receives, she supplies 1,000 gallons of water per day. Because she supplied 1,000 gallons of water per day, the price paid by the villagers remains equal to $2.00, the price at which 1,000 gallons per day is the quantity demanded. Sheryl receives $1.50, the $2.00 paid by the villagers minus the $0.50 sent to the government as the tax.
b) The government receives $500 in tax revenue.
c) Sheryl pays 100 percent of the tax because the price she receives falls by the full amount of the tax. The villagers pay none of the tax because the price they pay does not change.