Question

The politicians in the federal government were trying to look good in the next election. So they targeted a well-known national monopoly and raised the tax rate specifically on the profits of that monopoly. The tax rate was raised from 21 percent to 50 percent. The politicians were so proud of what they did and they started to brag in public that they were helping the people. Question: Will the monopoly truly lose that extra money that they paid in taxes and will they have no way to get it back?

• This type of profits tax is illegal in America. The government only has two choices. Either leave the monopoly alone or try to break them up into smaller firms.

• The monopoly won't be able to recover. All the extra taxes that were paid is lost. The monopoly will never be able to recover that lost money ever again.

• This is false because a smart monopoly would cut prices in order to sell more and make enough revenues to pay any additional taxes and they would still be able to effectively maintain their MC = MR profit maximization.

• This is false - the monopoly can almost always raise prices and will lose nothing or almost nothing in terms of profits because they have an inelastic demand curve.

Answer 1

Since the tax is increased on profits of the monopolist, so the total tax paid is a fixed cost. The marginal cost of production of the Monopolist does not change. So depending on the marginal cost and marginal revenue, the monopolist decides his output quantity. Now depending on the demand curve and the output quantity, the price is set. The difference between the price and the average cost of production is the profit of the monopolist.

Now let us say that a percentage of this profit is taxed. Since the tax will reduce the overall profits without any change in revenue, we can assume that it is a part of the average cost. The average cost is a function of the marginal cost and fixed cost. The marginal cost is the cost to produce an additional product. Since the increase in the product is irrelevant in taxing the profits, so the marginal cost does not change. So the fixed cost must have changed to increase the average cost.

Thius we can conclude that tax on profit is a fixed cost. So the monopolist still has maximum profits at the same quantity and thus the price remains the same. So imposition of the tax reduces the profits of the monopolist and there is no way for the monopolist to get back the money in any way.

In case the monopolist decides to increase the products the price will fall. The marginal cost will rise. So there is a overall decrease in profit. Added to this will be the added taxation. So effectively the profit will go down.

Thus the best case scenario for the monopolist is to produce as before the tax was imposed.

So the correct option is

The monopoly won't be able to recover. All the extra taxes that were paid is lost. The monopoly will never be able to recover that lost money ever again.

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