You are an assistant to a senator who chairs an ad hoc committee on reforming ta
ID: 1138144 • Letter: Y
Question
You are an assistant to a senator who chairs an ad hoc committee on reforming taxes on telecommunication services. Based on your research, AT&T has spent over $15 million on related paperwork and compliance costs. Moreover, depending on the locale, telecom taxes can amount to as much as 25 percent of a consumer’s phone bill. These high tax rates on telecom services have become quite controversial, due to the fact that the deregulation of the telecom industry has led to a highly competitive market. Your best estimates indicate that, based on current tax rates, the monthly market demand for telecommunication services is given by Qd = 300 - 4P and the market supply (including taxes) is QS = 2P - 120 (both in millions), where P is the monthly price of the telecommunication services. The senator is considering tax reform that would dramatically cut tax rates, leading to a supply function under the new tax policy of QS = 2.5P - 120. How much money per unit would a typical consumer save each month as a result of the proposed legislation?
Explanation / Answer
In pre-tax equilibrium, equating QD and QS,
300 - 4P = 2P - 120
6P = 420
P = $70
Q = 300 - (4 x 70) = 300 - 280 = 20
In after-tax equilibrium equating QD and new QS,
300 - 4P = 2.5P - 120
6.5P = 420
P = $64.62 (Price paid by buyers)
Unit savings per month = Pre-tax equilibrium price - After-tax price paid by buyers = $70 - $64.62
= $5.38
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