PROBLEM #2 Suppose a coastal city decides to impose a per-unit tax on luxury yachts to...

PROBLEM #2 Suppose a coastal city decides to impose a per-unit tax on luxury yachts to generate funds to support a wind-farm power project. Consumers in the market for luxury yachts typically monitor the price of yachts well in advance of purchasing them, given the significance of the cost of a yacht relative to their income. Yacht suppliers use equipment and resources that are uniquely suited to producing high-end yachts, and are unable to easily switch to producing other types of boats. PROBLEM #2 CONTINUED Based on the information above, determine which side of the market (supply or demand) is more price elastic. Draw a sketch of the supply and demand in this market, in which the relative slopes reflect the relative elasticities you have noted. On your graph, show the impact of the tax on this market, with your graph showing clearly who will bear the greater percentage of a luxury-yacht tax burden, producers or consumers. (Assume that the sellers make the tax payments to the government.)

Solutions

Expert Solution

Yatch is considered to be luxury good and it is purchased by people who have a higher income compared to others. We know, that the elasticity of demand for luxury goods is highly elastic. This means that a slight increase or decrease in the price of the good, will result in a great change in the demand for that good by the consumers. Moreover, luxury goods also tend to have a high elasticity of supply. As the prices increase, supply of luxury goods also increases. Thus, we have a leftward shift of the demand curve and the supply curve shifts rightwards. Hence, we have a new equilibrium where the equilibrium price is lower than the previous price at equilibrium. But we can see that with the fall in price, the quantity per period also falls.

Here D₂ and S₂ are the original demand and supply curves respectively. They change in prices due to taxes cause the demand curve to shift from D₂ to D₁ and the supply curve shifts from S₂ to S₁.

The tax incidence depends on the relative price elasticity of supply and demand. When supply is more elastic than demand, buyers bear the tax burden. When demand is more elastic than supply, producers bear the cost of the tax.

In this situation, we have that the demand is more elastic than supply. Thus, the producers bear the burden of the tax.

Rahul Sunny answered 1 year ago

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