Question

1- The impact of tax on markets and welfare distribution. [70 points, 10 points each part]

Use supply and demand diagrams to answer the following questions. Draw new diagrams for answers to EACH part.
a- Show that regardless of who the tax is levied on (consumers or producers), a tax increase the price paid by consumers, decrease the price received by producers, and make the market smaller compared with a free market. Notes: You should use two diagrams, one for tax on consumers and one for tax on producers.
b- Show that regardless of who the tax is levied on (consumers or producers) the burden of tax will be shared between consumers and producers
c- Show that the burden of tax falls more heavily on relatively more inelastic side of the market.
d- Show that the greater the elasticity of supply and demand, the greater the deadweight loss of a tax.
e- Show that the greater the elasticity of supply and demand, the smaller the tax revenue generated by a given tax.
f- Show that, fixing elasticity of supply and demand, the impact of an increase in tax rate on tax revenue depends on whether the initial tax rate is “too low” or “too high”.
g- Show that the relatively more elastic side of the market benefits relatively less from a given tax cut.

Thank you!

Answer 1

The implication of tax creates a dead weight loss which reduces the equilibrium economic output in an economy. It also causes a reduction in consumer and producer surplus.

A.

Case I - when tax is imposed on consumer

In this case the demand curve would shift leftward causing a fall in output. The initial price paid by the consumers equals the price received by the seller, but after the imposition of tax price paid by buyers increase and the one received by seller falls.

Case II - when tax is imposed on producer

The supply would shift leftward due to an increase in cost of production. Similarly, the price paid by the buyer increases and the price received the seller decreases.