Question

Qs=2p, Qd=12-p

The following is the quantity demanded and quantity supplied of in a market? (1)

What is the market equilibrium price and supply for the market above? (1)

If there was a tax of 6 dollars on firms how much will the firms receive from the buyers, how much will consumers pay for good, how much will the government make in revenue? (1)

What types of goods tend to be inelastic? Should the government tax these types of goods, Why or why not? (2)

Answer 1

Answer – The demand function is Qd=12-p and the supply function is Qs=2p.

Equilibrium occurs when Qd = Qs.

Thus, equating Qd = Qs, we get, 12 – p = 2p;

Or, 3p = 12;

Or, p = 4.

Therefore, the market equilibrium price = $4.

The market equilibrium quantity = 8 units.

If there was a tax of 6 dollars on firms, then the new supply curve would be Qs = 2(p-6) = 2p – 12.

So, new equilibrium occurs when the new supply curve and demand curve intersect.

Thus, equating Qs = Qd, we get,

2p – 12 = 12 – p;

Or, 3p = 24;

P = 8.

So, the price paid by the consumers after tax for the good = $8.

The quantity in the market = 2*8 – 12 = 4 units.

The price received by the sellers from the buyers after tax = 4/2 = $2.

The tax revenue collected by the government = 4 * $6 = $24

Goods for which the proportionate change in quantity demanded/supplied as a response to a % change in price is less is known as inelastic goods. Essential goods such as electricity or gas or goods of addiction such as cigarettes are known as inelastic goods.

The government should tax inelastic goods because the government can collect more tax revenue from such goods. We know that when tax is imposed by the government, then the burden of the tax falls more heavily on the side of the market that is considered to be relatively more inelastic. This is because when tax increases the price of the goods, the buyers cannot reduce the quantity demanded for the good drastically if the good has inelastic demand. Similarly, when tax decreases the price received by the sellers from the buyers, the sellers cannot reduce the quantity supplied of the good drastically if the good has inelastic supply. In such cases, even if tax increases the price of the good, the market quantity does not fall and so maximum tax revenue can be collected the government.

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