Demand and Supply Effects

The question of who pays for regulation can seldom be determined merely by identifying tax incidence the fined, taxed, or otherwise regulated party. Although the point of tax collection, or the tax

Point of tax collection incidence, of pollution charges may be a given corporation, this tax burden may be passed tax burden on to customers or suppliers.

Economic cost of tax In general, who pays for operating control regulation depends on the elasticity of demand for the final products of affected firms. Figure 13.1 illustrates this issue by considering the theoretically polar extremes of perfectly elastic demand for final products, [Fig. 13.1(a)], and perfectly inelastic demand for final products, [Fig. 13.1(b)]. Identically upward-sloping MC curves are assumed in each instance. Here, as is often the case, regulation is assumed to increase marginal costs by a fixed amount per unit. This amount, t, can reflect pollution taxes per unit of output or regulation-induced cost increases.

Figure 13.1(a) shows that good substitutes for a firm's product and highly elastic demand prevent producers from passing taxes or regulation-induced cost increases on to customers. In this case, producers—including investors, employees, and suppliers—are forced to bear the burden of regulation. Falling rates of return on invested capital and high unemployment are symptomatic of such influences.

Figure 13.1(b) shows the effect of regulation-induced cost or tax increases in the case of perfectly inelastic final-product demand. Without substitute products, producers can pass the burden of regulation on to customers and encounter relatively few disadvantages because of regulation-induced cost increases. When demand is inelastic, the consumer pays for regulation.

Although the preceding analysis is greatly simplified, it shows that taxes or regulation-induced cost increases have differing effects when demand relationships vary. Similarly, the effect of regulation on industries with similar product-demand elasticities varies to the extent that supply characteristics differ.

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