Suppose the Federal Government would like to levy a new specific per unit tax. T

Question

Suppose the Federal Government would like to levy a new specific per unit tax. They need your help as you are a member of the Council of Economic Advisers in trying to figure out on which good they should assess this new tax. The following scenarios describe the current situation in the two potential markets:

Scenario A

N=1.0 E= -1.5

Scenario B

Qs= 3p Qd= 100-2p

Part a: Find the incidence of the tax on consumers in Scenario A (Enter as a decimal and round to one decimal place).

Part b: Find the incidence of the tax on sellers in Scenario B (Enter as a decimal and round to one decimal place).

Part c: In which scenario is the incidence of the tax greater on consumers?

Part d: The President would like a report on your previous findings. Specifically, he would like you to provide an explanation for why the burden of the tax is greater in the scenario you choose in the previous question.

Part e: If the proposed tax is a $6, the change in price paid by consumers in scenario A is________and change in price paid by consumer in scenario B is_________.

Part f: If the government had the option to tax either the good from scenario A or scenario B, which one would you recommend they tax to earn the most revenue? Why?

Explanation / Answer

Answer:

a)

Incidence of tax on consumers is given by the percentage of tax shared by consumers = supply elasticity / supply elasticity + demand elasticity = 1/(1 + 1.5) = 0.40.

Hence the Incidence of tax on consumers is 0.40 or 40%.

b) Incidence of tax on consumers is given by the percentage of tax shared byseller

Qs = 3p

Qd = 100-2p

by equlibrium

Qs = Qd

3p = 100-2p

p = 100/5

p = 20

Qs = 3*20 = 60%

c) From A ans B scenario's I can say that Scenario A has incidence of the tax greater on consumers, but it is more elastic

d)

Scenario 1)

E = -1.5

Scenario 2)

3P = 100 - 2P

5P = 100

P = 100/5

=20

Q = 3(20)

= 60

Ed = dq/dP * P/Q

= - 2 *20/60

= 40/60

= - 0.66

Demand more elastic in scenario 1, thus tax should not be levied on first market.

It should be imposed in market 2 only because demand is inelastic here.

e) from scenario A

n=1 and E= -1.5

Tax burder on consumer = n/n+e

  (absloute value hence E is +ve) = 1/1+1.5

= 0.4

The change in price paid by consumers in scenario A is = 0.4*6=2.4

  from scenario B Qs= 3p Qd= 100-2p

by equlibrium

Qs = Qd

3p = 100-2p

p = 100/5

p = 20

supply tax of $6

Qs = 3(p-6) = 3p-18

by equlibrium

  3p-18 = 100-2p

p = 23.6

change in price paid by consumer in scenario B is 23.6 - 20 =3.6

f)

Scenario A)

E = -1.5

Scenario B)

3P = 100 - 2P

5P = 100

P = 100/5

=20

Q = 3(20)

= 60

Ed = dq/dP * P/Q

= - 2 *20/60

= 40/60

= - 0.66

Demand more elastic in scenario 1, thus tax should not be levied on first market.

It should be imposed in market 2 only because demand is inelastic here.Revenue collection will increase only if demand happens to be inelastic.

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