When a tax is imposed on sellers of a good, the resulting rise in the equilibrium price is usually less than the amount of the tax itself. Why doesn't the equilibrium price rise by the full amount of the tax?

What will be an ideal response?

Because firms collect taxes from consumers and send them to the government, the taxes drive a wedge between the price or dollar amount firms receive from consumers and the price or dollar amount they get to keep for selling the good. Firms would like to raise the price by the full amount of the tax. In this case, the price firms receive would stay the same and so the firms would continue to supply the same amount of the product. But as the price rises, the quantity demanded decreases. Hence, if the price rose by the full amount of the tax, the quantity supplied would not change and the quantity demanded would decrease. There would be a surplus of the product. The surplus forces the price downward, thereby making the rise in price less than the full amount of the tax. As a result, in the equilibrium the price generally does not rise by the full amount of the tax.

Economics

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