Question

In the town of Kokomo, Marylin owns a well, which is the only source of drinking water. The supply of water is perfectly inelastic at a quantity of 1,000 gallons of water per day. At a price of $2.00 per gallon, the quantity demanded per day is 1,000 gallons. The government imposes a $0.50 per gallon tax.

After the tax is imposed, what is the price paid by the villagers? What is the price received by Marylin? What is the tax burden?

Explain with words + graph.

Answer 1

The perfectly inelastic supply curve is a vertical line along y axis

In the statement,the supply curve is inelastic at quantity of fix 1000 gallons of water,while no information regarding demand curve,so we will assume unit elastic demand (=1)
See the graph below------

We find initial equilibrium point E where D and S intersect each other.

Equilibrium quantity = 1000 gallons

Equilibrium price =$2 per gallon

Now govt imposes a tax @$0.50 per gallon of water

As the supply is perfectly inelastic------

THE WHOLE BURDEN OF TAX WILL BE BORNE BY THE PRODUCER

Because buyers remain unaffected by the imposition of govt tax ,the producers are insensitive to price chang,will bear the whole tax burden

The demand curve D will shift to D' if the producer shifts the tax burden upon buyers.

#Price paid by villagers=$2 per gallon

#Price received by Marilyn=$1.5

(2--0.5)

#Tax burden=$ 500

Calculation-----

quantity ( in gallons)* tax per gallon

1000 * 0.50 =$ 500