Question

Assume that the government decides to impose a tax on sellers of foods that are high in sugar content. a) Using a demand and supply diagram (half an A4 page), demonstrate and explain how such a tax that is imposed on sellers in fact creates a burden on consumers as well. Indicate the government revenue on your diagram. b) What is price elasticity of demand and how is it calculated? Briefly explain using diagrams, how price elasticity of demand will play a role in determining the size of the burden on consumers. c) Define allocative efficiency. What are all the possible economic scenarios when such a tax could be allocatively efficient, and thus create no deadweight loss?

Answer 1

a) by imposing tax on seller supply curve shift leftward from S to S' in this S is the before tax supply curve and S' is the after tax supply curve before tax price is P and after tax it is P' quantity reduces from Q to Q' .price the consumer pay is P' it was a tax pf P₂ and the price before was P.the price consumer pay is P' but producer don't get price P' because they have to pay P₂ as tax so they get P_{2 .}the shaded area shows government tax revenue at new quantity of Q'.

b) price elasticity of demand, or elasticity, is the degree to which the effective desire for something changes as its price changes. In general, people desire things less as those things become more expensive.

it is calculated by the percentage change in quantity demanded—or supplied—divided by the percentage change in price.

above on the left, the supply is inelastic and the demand is elastic consumers may have other choices, sellers can’t easily move their businesses. By introducing a tax, the government essentially creates a wedge between the price paid by consumers,P₂ and the price received by producers,P₁ In other words, of the total price paid by consumers, part is retained by the sellers and part is paid to the government in the form of a tax.The distance between P₂ and P₁ is the tax rate. The new market price is P₂ but sellers receive only P₁ per unit sold since they pay P₂-P₁ to the government. Since a tax can be viewed as raising the costs of production, this could also be represented by a leftward shift of the supply curve. The new supply curve would intercept the demand at the new quantity Q_1.the tax burden falls disproportionately on the sellers, and a larger proportion of the tax revenue the shaded area is due to the resulting lower price received by the sellers than by the resulting higher prices paid by the buyers.

similarly in which demand is inelastic and supply is elastic. The tax incidence now falls disproportionately on consumers, as shown by the large difference between the price they pay, P₂, and the initial equilibrium price, p.Sellers receive a lower price than before the tax, but this difference is much smaller than the change in consumers’ price.The more elastic the demand curve, the easier it is for consumers to reduce quantity instead of paying higher prices.

c) allocative efficiency occurs when there is an optimal distribution of goods and services, taking into account consumer’s preferences.

A more precise definition of allocative efficiency is at an output level where the Price equals the Marginal Cost of production. This is because the price that consumers are willing to pay is equivalent to the marginal utility that they get. Therefore the optimal distribution is achieved when the marginal utility of the good equals the marginal cost.

scenario 1

A common misperception is that if a seller is taxed, then the buyer does not pay for this. As we have seen, the buyer pays for a tax through their consumer's tax burden and deadweight loss.

scenario 2

the impact of a tax on a market if it is the buyer of the good that is taxed.  In this case, demand will decrease by the amount of the tax.A common misperception is that if a buyer is taxed, then the seller does not pay for this. As we have seen, the seller pays for a tax through their producer's tax burden and deadweight loss.

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