Question

Daniel’s Midland Archers (DMA) makes children’s wooden practice arrows. Draw a set of representative short-run cost curves for DMA. Include average variable cost, average fixed cost, average total cost, and marginal cost.

1) Suppose that Congress imposes a 39-cent excise tax on each children’s wooden arrow DMA sells. Illustrate the effects of this tax on the cost curves of DMA. Which curves shift and which do not?

2) Suppose that the city where DMA manufactures the arrows increases the annual property tax on DMA’s factory from $80,000 to $150,000. Illustrate the effects of this tax on the cost curves of DMA. Which curves shift and which do not?

Answer 1

In following graph, AVC0, AFC0, ATC0 and MC0 are initial average variable cost, average fixed cost, average total cost and marginal cost curves. AFC0 curve is continuously downward sloping without touching any axes. AVC0, ATC0 and MC0 are U-shaped, and MC0 intersects AVC0 and ATC0 at their minimum points.

(1) A unit tax like an excise tax will increase AVC, ATC and MC, therefore shifting AVC0, ATC0 and MC0 upward to AVC1, ATC1 and MC1 respectively, with MC1 intersecting AVC1 and ATC1 at their minimum points. Fixed costs will remain unchanged, so AFC0 will not change.

(2) An increase in property tax will increase fixed cost, thus increasing AFC, shifting AFC0 upward to AFC1. Since variable costs will remain unchanged, AVC0 and MC0 will not change. Higher fixed cost will increase total cost, so ATC will increase, shifting ATC0 upward to ATC1. The MC0 curve will intersect ATC1 at its minimum point.