4. Tax Incidence: How do the effects of a tax differ between markets with different elasticities...

4. Tax Incidence: How do the effects of a tax differ between markets with different elasticities of supply? Consider two hypothetical markets. In both cases, the demand function is

QD = 450 -.5P

The two supply functions are

QS1 = .5P - 50

and

QS2 = P - 300

a. Solve for equilibrium price and quantity for both cases and show that the equilibrium values are the same in these two cases (for QS1 and QD and for QS2 and QD). Plot the inverse supply and demand functions (with P as function of Q) for the two markets on the same graph.

b. Now suppose a tax is imposed in both markets, equal to $100 per unit purchased. Model this as a shift in the demand curve (so that QD now depends on P, the net price paid to the firm, plus the tax). Illustrate the new demand curve on your graphs (label everything clearly). Derive the new equilibrium price (the net price received by the firm) and quantity for each of the two cases. In which case is the producer’s share of the tax burden greater?

c. Calculate deadweight loss in each case. In which case is deadweight loss greater?

Expert Solution

Rahul Sunny answered 1 year ago

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