Tax on Producers and Consumers

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Question 1

Figure 1.1- A tax on Producers

a) i) Equilibrium Price and Quantity before tax:

100-10Q = 20 +10Q

∴ 20Q = 80

∴ Q = 4

When Q = 4, P = 60

∴ Equilibrium price equals $60 and equilibrium quantity is 4 million

ii) Consumer Surplus = ½ x 4 x 40

= 80

Producer Surplus = ½ x 4 x 40

= 80

iii) An efficient market occurs when total surplus is maximized. This equilibrium of P = 60 and Q = 4 has maximized consumer and producer surplus equally. It is at this point where the marginal cost of production equals marginal benefit.

Question 1 cont.

b) i) After imposing a tax of $20, being levied on the producers, the price paid by buyers is $70 and the price received by sellers is $50 per unit of mobile phones sold at the reduced quantity supplied of 3 million. This is illustrated in figure 1.1 with the shift in the supply curve from S1 to S2.

ii) Consumer Surplus = ½ x 3 x 30

= 45

Producer Surplus = ½ x 3 x 30

= 45

iii) There is a decrease in the total surplus after the implementation of a tax on mobile phones. A substantial portion of the total surplus has been redistributed to government tax revenue, however, there is a deadweight loss. Marginal social benefits exceed marginal social costs, resulting in inefficiencies within the market for mobile phones.

c) Expected Total Revenue = 3 x 20

= $60 million

Expected Deadweight Loss = 2 ( ½ x 1 x 10 )

= $10 million

d) The distribution of real incidence is the amount of burden of a tax shared between the buyer and seller. This proposed tax shares the burden of the $20 equally between buyers and sellers. The distribution of real incidence on buyers is a $10 rise in the price paid on sellers is the $10 decrease in price received for each mobile phone.

e) Elasticity of Demand = Ave. P x ΔQ

Ave. Q ΔP

= 65 x (-1)

3.5 10

= -1.857142857

∴ Elasticity of Demand equals 1.857

The Elasticity of demand is greater than one which means the demand for mobile phones is elastic. The percentage decrease in the quantity demanded exceeds the percentage increase in price. This tax would mean as there is a 1% increase in price there is a 1.857% decrease in quantity. There is also a decrease in the total revenue as the price increases.

Question 2

|  |Printer |Kilogram of Rice | |Thailand |100 |5 | |India |90 |3 |

Figure 2.1- Thailand’s Production Possibility Frontier

Figure 2.2- India’s Production Possibility Frontier

Question 2 cont.

|  |Printer |Kilogram of Rice | |Thailand |36 |1080 | |India |40 |1800 |

c) Points seen in Figure 2.1 and Figure 2.2

d) - Thailand’s opportunity cost of producing 1 printer is 20kgs of Rice -...
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