A Tax Levied on a Monopoly Consider Exercise 2. Assume that a 2% tax is levied o

Question

A Tax Levied on a Monopoly Consider Exercise 2. Assume that a 2% tax is levied on the monopolist's profits. Does this have any effect on its choices of output level and output price? Consider now a quantity tax of $1 per output unit sold. Compute the optimal output level and the corresponding output price. How does this tax affect the monopolist's choices of output and price, and its profits? (Note that a quantity tax of $1 per output unit sold is equivalent to raising the marginal cost by $1. Why?) We say that the monopolist passes on the tax to the consumer if it raises the price by more than the tax ($1 here). Is this the case with the quantity tax in (2)?

Explanation / Answer

1) A tax on monopoly's profits will reduce the profit. Its implications are simple, profits tax has no effect on monopolist’s choices of output, price or input demands and that is why the profits tax is called a neutral tax.

2) A per unit tax on monopoly is distortionary. It increases the the marginal cost of production by the tax amount since per unit tax implies dollar value of tax added to MC when it is derived as a derivative from TC. This also reduces the profit-maximizing output. In turn the profit maximizing price rises.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.