(a) Evaluate how an increase in price of petrol may impact taxi fares for consumers. [15 marks]

– Define tax: indirect tax is a tax levied on goods and services, it is levied on producers who then pass on to consumers in terms of higher prices

– Define PED: PED refers to the degree of responsiveness of quantity demanded to a given change in price of the product

Taxi Fuel Price Elasticity Diagram

– Inelastic demand: More of the tax burden is pushed on to the consumers because despite the increase in price from P to Pt, the decrease in quantity demanded is less than proportionate than the change in price. Producers know that consumers are likely to purchase this good despite price change,  hence consumers are more likely to bear the tax burden passed on from producers. This is usually the case of alcohol and cigarettes, which have little substitutes and form a relatively low proportion of income. In which case, producers are likely to pass on the burden to consumers. And since the total amount of tax imposed by the government is the difference between the supply curves measured on the Y-axis (price curve). Consumers paid a price increment for the top portion from P to Pt, producers must have taken the burden at the bottom.

In the case where demand for taxi is price elastic, a rise in price of petrol is likely to lead to a small increase in price. A rise in price of petrol leads to a drop in supply of taxi since cost of production increases.

If demand is price elastic, a leftward shift in supply leads to a rise in price and drop in qty dd. The price increase will be small and there is a more than proportionate drop in qty demanded. As such, taxi drivers are likely to experience a drop in total revenue. This is because the gain in total revenue from rise in price is likely to be less than loss in revenue from decrease in output. Hence, taxi drivers are only going to pass on a small price increase to consumers.

Demand Price Elasticity Diagram

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