Question

A firm pays a monthly tax, which is a fixed amount, regardless if it produces any output. a. Explain the effect that this tax has on the firm’s fixed cost, marginal cost, average variable cost and average total cost? b. Next assume that the firm is charged a tax proportional to the number of units it produces. How does this tax affect the firm’s fixed cost, marginal cost, average variable cost and average total cost? Explain.

Answer 1

a.When the firm pays a monthly tax, which is a fixed amount, regardless if it produces any output , this tax is considered as its fixed cost . Thus this tax will increase its fixed cost , thus total cost will be effected and total cost will increase. Average total cost will be also effected due to this fixed cost . As it is fixed cost , it does not have any effect on variable cost thus it does not have any effect on average variable cost , similarly it will not have any effect of marginal cost.

b, If the firm is charged a tax proportional to the number of units it produces.as the number of produced unit increases the tax will increase , it will be now considered as variable cost. Fixed cost will be uneffected but total cost will be higher which lead to have higher average total cost, higher average variable cost and higher marginal cost.