Demand and supply curves shift either to the right or to left because of a change in any or all of their determinants other than the price of the commodity.

A shift in the demand curve occurs because of a change in any or all of the factors which are taken to be constant while drawing the demand curve. Similarly, a shift in the supply curve occurs because of a change in any or all the factors that are taken to be constant while drawing the supply curve.

The change which occurs in demand and supply as a result of their shifts are respectively called a ‘change in demand’ and a ‘change in supply’. On the other hand, the change which occurs in them as a result of a change in price ie, as a result of movement along them, is called a ‘change in quantity demanded’ (ie, extension/ contraction of demand) or a ‘change in quantity supplied’ (ie, extension/contraction of supply) as the case may be.

We shall now briefly see the impact and implications of shifts in demand and supply curves as a result of taxation. The analysis will ignore the diagrams and will focus on the results.
Shifts in demand curve may come through changes in income, tastes (non-monetary factors) and prices of other commodities, and shifts in supply curve through changes in factor prices, technology and the firm’s objective.

Before we consider the effects of a tax which is levied on the given commodity, let us analyse the mechanics of the shifts on the supply and demand curves.

Suppose that the demand curve shifts to the right and the buyers and sellers are knowledgeable about this shift and know for certain that the shift is permanent. Given the long-run supply curve, this results in a condition of excess demand. We are interested to find as to how this excess demand is eliminated. Much would depend upon the response of supply to a change in demand and the degree of this response would depend upon the availability of time over which supply may change. In this context, we may distinguish three cases:

Case 1: Immediate short-run

Knowing that the supply can’t be immediately increased the price will rise. Hence, the immediate short-run response of supply to a change (rise) in demand is zero. In other words, the whole of the excess demand is completely eliminated by a rise in the price.

Case 2: Short-run

In case there is an extension in supply along a short-run supply curve, the price comes down and the corresponding quantity also comes down. This is the short-run supply response (may be by overtime working) to a change (rise) in demand. The result is a decline in price, and a part-elimination of excess demand

Case 3: Long-run

In case there is an extension in supply along a long-run supply curve, the price comes down and the corresponding quantity also comes down. This is the long-run supply response of supply (due to the building of more plant and equipment etc) to a change (rise) in demand. The result is a decline in price, and the excess demand is completely matched by additional production.
One can also look at an alternative extreme situation when demand curve shifts to the right, but the buyers and sellers are uncertain about the shift in the sense of its being permanent or temporary.

The comparative-static analysis of this leads to the following results:

As a result of a right-ward shift in the demand curve, the excess demand becomes more. Since buyers and sellers are uncertain about the shift in the demand curve, the shift is not taken seriously, and as a result, price does not rise ie, it stays where it was initially and excess demand results with some non-price rationing of demand operations. As time passes on, some of the uncertainty is dispelled and price rises along the short-run supply curve. At last (ie, in the long period) the price falls. The difference between the two situations lies in the time paths of price and output. In the first case (when market is certain), price shoots up immediately and then declines to the equilibrium level. In the second case (when market is uncertain) price rises with a time-lag. In the first case price moves to clear the market, and in the second case, stocks may be run down.

For theoretical analysis it is fair to assume that the first situation, when buyers and sellers are fully aware of the market, is more relevant. We must also note that leaving the cases of perfect inelasticity and perfect elasticity of demand or supply curves, a shift in either demand or supply would change both price and output.

We are now in a position to use this analysis to consider the effects of a tax which is levied on each unit produced of the commodity. As a result of the imposition of such a tax, producers now require a higher price in order to cover the tax. The supply curve would, therefore, shift vertically upwards to the left. The extent of the shift would be such that the price of each unit of the commodity covers the tax.

The levy of the tax does not change the position of the demand curve, as its position is fixed by income and tastes. Equilibrium before tax is attained at the point of intersection of the demand and supply curves and after tax it changes to another point of intersection of the given demand curve and the left-ward shifted supply curve. This point of intersection is, therefore, higher than the initial point of intersection. The price- increase as a result of tax is less than the tax- increase. As a result of the tax, consumers reduce the amount of the commodity. For each unit of consumption, they pay a given tax (equal to the price difference of the two equilibrium situations) per unit. The remaining portion of the tax per unit is borne by the producers.

The sharing of the tax between the consumers and producers will, however, depend upon the relative price-elasticities of demand and supply. Let us exemplify this by considering two extreme possibilities: