If the government decides to impose a tax of 20 cents per litre on petrol, illustrate...

If the government decides to impose a tax of 20 cents per litre on petrol, illustrate the impact of the tax on market equilibrium price, and discuss whether the outcome is efficient by demonstrating the change of consumer’s and producer’s surplus as a result of the tax.

•Draw a demand and supply model, with demand curve.

•Show the shift of S as a result of 20 cent tax.

•Identify new equilibrium.

•Mark the price paid by consumer and received by the seller.

•Demonstrate change of consumer and producer’s surplus, tax revenue, and deadweight loss.

Expert Solution

Sol :

Equilibrium is the point where demand and supply are equal to each other.

When tax of $0.20 cents is imposed by the government , Supply curve of the product will shift to the left because of the decrease in supply due to increase in taxes.

When supply curve shift from S to S1, a new equilibrium is established where E1 (Equilibrium is established) .

Price charged corresponding to E1 is Pc (Price Paid by consumer) and Pp (price paid by the producer) .

Deadweigh loss is the loss of trade because of imposing of taxes.

And , consumer surplus is the area above the price level and below the demand curve . Whereas producer surplus is the area below the price and above the supply curve .

Consumer surplus is reduced and producer surplus is also reduced because of taxes .

Rahul Sunny answered 2 years ago

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