Question

explain your answer using diagrams where appropriate.

1/Evaluate this statement: “As a global pandemic causes a fall in consumer confidence and difficulties in the supply of product X, the price of product X will definitely rise”. True/False/Uncertain. Explain.

2. Evaluate this statement: ‘Consumers bear a greater portion of tax incidence when demand is inelastic.’ True/False/Uncertain? Explain.

3. Evaluate this statement: In monopolistically competitive markets products are identical and entry is free. True/False/Uncertain. Explain.

Answer 1

As a global pandemic causes a fall in consumer confidence, consumers demand of product X will fall and the demand curve for product X will shift leftward from D1 to D2. Now, as the difficulty in the supply of product X arises, the supply of product X will fall and the supply curve of product X will shift leftward from S1 to S2.

Now, when the leftward shift of the demand curve is higher than the leftward shift of the supply curve, then as the economy moves from point A to point B, the equilibrium price declines from P1 to P2 and the equilibrium quantity declines from Q1 to Q2. (Panel 1)

Now, when the leftward shift of the demand curve is smaller than the leftward shift of the supply curve, then as the economy moves from point A to point B, the equilibrium price increases from P1 to P2 and the equilibrium quantity declines from Q1 to Q2. (Panel 2)

Now, when the leftward shift of the demand curve is same as the leftward shift of the supply curve, then as the economy moves from point A to point B, the equilibrium price remains unchanged at P and the equilibrium quantity declines from Q1 to Q2. (Panel 3)

Hence the price of product X can decline, rises or remain unchanged. Hence the above statement is uncertain.

2. The tax falls more heavily on the side of the market which is less elastic because as the market price rises due to the imposition of the tax, consumers cannot easily leave the market as not many substitutes are available due to inelastic demand for the product. From the figure, the demand curve is relatively inelastic than the supply curve i.e demand curve is relatively steeper than the supply curve. Here pre-tax equilibrium price is P0. Due to the imposition of a tax of 't', the price paid by buyers is Pb and the price received by sellers is Ps. Hence here the burden of the tax on consumers i.e Pb-P0 is higher than the burden of the tax on sellers i.e P0-Ps. Hence the above statement is true.

3. In a monopolistically competitive market, there is free entry in the market like a perfectly competitive market, but each firm sells slightly differentiated products, not identical products. Hence the above statement is false.