Question

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.

Answer 1

a.

Tax on producers shifts the supply curve to the left.

Before tax Equilibrium quantity= Q*

Aftet tax Equilibrium quantity= Qt

Price paid by consumers rises from P* to Pd.

Price received by producer falls from P* to Ps.

Equilibrium shifts from E to E'.

b. After tax, consumer surplus falls as the price paid by consumers rises and producer surplus also falls as the price received by producers falls.

There is a deadweight loss in the society as the efficient quantity is not produced.

c. Three reasons are government may impose tax-

1. To deal with negative externality.

2. To gain government revenue .

3. To reduce the production and consumption of harmful products like drugs, alcohol .

When tax is imposed, there is a fall in the equilibrium quantity depending on the Elasticity of demand and supply.

The more elastic the demand is, less will be the government revenue and more will be the deadweight loss.

The less elastic the demand is, more will be the government revenue and less will be tge deadweight loss.