A tax has a notable effect on market equilibrium, resulting in an increase in the equilibrium price and a decrease in the equilibrium quantity of a good or service.

When a tax is levied on a specific good or service, it directly influences the market equilibrium—the point where the quantity demanded by consumers equals the quantity supplied by producers. This influence typically manifests as a rise in the equilibrium price and a decline in the equilibrium quantity.

The introduction of a tax raises production costs for suppliers. To offset these increased costs, suppliers may either reduce the quantity of the good or service they produce or raise the selling price of that good or service. In most cases, both actions occur to some extent. The heightened selling price is often passed on to consumers, leading to an increase in the equilibrium price.

As the price rises, the quantity demanded by consumers tends to decrease, in accordance with the law of demand. This law states that, all else being equal, an increase in the price of a good or service results in a decrease in the quantity demanded. Consequently, the imposition of a tax results in a lower equilibrium quantity.

The degree to which the equilibrium price increases and the equilibrium quantity decreases is influenced by the price elasticity of demand and supply. If demand is elastic—indicating that consumers are sensitive to price changes—then the increase in price will trigger a significant reduction in quantity demanded. Conversely, if demand is inelastic—meaning consumers are less responsive to price changes—the drop in quantity demanded will be less pronounced.

Similarly, if supply is elastic—indicating that producers are sensitive to changes in production costs—the increase in costs will lead to a substantial decrease in quantity supplied. If supply is inelastic—indicating that producers are relatively unresponsive to cost changes—the decrease in quantity supplied will be less significant.

In summary, the imposition of a tax affects market equilibrium by raising prices and lowering quantities. However, the magnitude of these changes is contingent upon the elasticities of both demand and supply.