Using simple demand-supply tools we will now examine the effects of this decision on the market for short-haul flights. The new price-quantity equilibrium must satisfy the following two equations:
The price-quantity equilibrium with APD = £11, is shown by points A and B in Fig: 1. The fare that the consumers pay is given by Pd1 and the amount that the sellers receive is shown by Ps1. The difference between these two prices, given by AB (= £11), is collected as the duty fee per unit by the government. The equilibrium supply of the short-haul trips is Q1.
Now with the hike in APD, demand curve falls further to D2. As again, the vertical distance between D2 and D0 is £12. The new equilibrium quantity and prices are now given by the points C and D. Fares that the buyers pay is now Pd2 and the sellers receive as much as Ps2. Again the difference between these two prices, i.e. CD (=£12) is taken as the duty fee per unit by the government. The equilibrium quantity of short haul trips now reduces to Q2. Thus the entire effect of this decision can be summarised below:
From the society’s point of view the dead weight loss from the taxation also rises. With APD = £11, it is equal to the area of the triangle ABE, but with the hike of £1 in APD, the dead weight loss will be equal to the area of the larger triangle CDE. Hence the deadweight loss or the loss in social welfare accumulates with this decision (Mankiw, 2008, p. 164).
Thus the buyers’ price will rise exactly by the hike in the rate of tax, i.e. £1, only if Ed = 0, which means the price elasticity of demand is equal to zero which further means that the demand curve is vertical and perfectly inelastic. In case of perfectly inelastic demand the buyers will not try to look for alternatives even if the price of that commodity rises. They will not try to shift their consumption to elsewhere very easily. Producers will, in such cases, try to take advantage of buyers’ strong inclination towards their product. They will pass the entire burden of increased taxes onto the buyers successfully. Thus if the demand is perfectly inelastic, buyers have to bear the entire burden of ...
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