Question

QUESTION 1

Suppose that the government of China decided to impose a per unit tax on the suppliers of salt.

a. Using a supply and demand model, show and explain the impact that the per-unit tax had on the equilibrium price and quantity of salt.

b. Using the diagram created for your answer to (a), show and explain what effect the per unit tax had on consumer surplus, producer surplus and deadweight loss.

c. List three reasons a government may impose a tax. Discuss the link between government revenue from taxation and elasticity of demand. [max words: 250]

Answer 1

a) Tax burden of tax imposed on producers will be shared by both producers and consumers. Tax will raise raise the price for consumer from PE and reduce the price producer receive from PE. After a per unit tax, quantity traded falls from QE to QT.

b) Before tax:

Consumer surplus is area of portion A + B + D

Producer surplus is area of portion C + E + F

Post tax:

Consumer surplus is area of portion A

Producer surplus is area of portion F

Government spending is area of portion B + C

Deadweight loss is area of portion D + E

c) Government impose tax due to:

• Generate tax revenue which can be spend on infrastructure building of economy.
• The main purpose could be that government wants to reduce supply of salt and producers are less elastic in supplying salt. Imposing tax will reduce the profit sellers receive from selling salt which induce them to sell less.
• There could be a reason that salt is an imported good and government have a substitute available of it. It induce them to reduce consumption of salt such that trade can be improved.