You have collected the following data on output and total variable costs: Q TVC
ID: 1108489 • Letter: Y
Question
You have collected the following data on output and total variable costs:
Q
TVC ($)
1
60
2
107
3
145
4
178
5
213
6
253
7
304
8
370
9
455
10
566
Suppose instead that the government considers your production process to be polluting, and imposes a $4 tax per unit produced. How does this tax increase compare to the property tax increase, in terms of the effect on your company’s cost curves?
Your boss says “either of these taxes is going to force us to change our production levels.” Given what you know about optimization analysis, how would you respond?
Q
TVC ($)
1
60
2
107
3
145
4
178
5
213
6
253
7
304
8
370
9
455
10
566
Explanation / Answer
A property tax is imposed on the property which means it is a lump sum tax and a lump sum tax increases the fixed cost but brings no change in the marginal cost or total variable cost. In contrast ad valorem tax such as the given pollution tax increases the marginal cost average variable cost as well as average total cost. In the diagram of a perfectly competitive firm such a tax will shift the marginal cost and the average total cost curve up. If the company was operating at zero economic profit condition it would now be forced to bear a loss. In the short run the firm cannot do anything because the price is not changed and firm cannot leave the industry. However in the long run when there is an option of exit the firm can leave.
If there is a Monopoly however it would have to observe that it's marginal cost has increased so it would have to reduce its production level to bring marginal revenue and marginal cost equalization at surface. In this way the pollution tax would reduce production and increase the price.
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