Question

Suppose the inverse demand for gasoline is given by p=10-QD/2.
a. Find the equilibrium price and quantity assuming supply is perfectly elastic and given by
MC=3.

In the U.S., gasoline is taxed on a per gallon basis, and the tax is paid by suppliers. Suppose the
tax is $0.5 per gallon of gasoline.

b. After the tax is imposed, what is the new equilibrium price and quantity? How much revenue
is raised by the tax?

c. What is the tax burden on consumers and producers? (in other words, what portion of the tax
is borne by consumers, what portion is born by producers?) How do these compare and why?
Calculate the deadweight loss of the tax.

d. Suppose the tax is increased from $0.5 to $1 per gallon. What is the new equilibrium, and
how much revenue is raised? What is the extra deadweight loss associated with this tax increase?
How does the deadweight loss of the tax increase from $0.5 to $1 compare to the deadweight
loss from a tax increase from $0 to $0.5? Why is this the case?

e. Repeat parts (b) and (c) assuming that the tax, rather than being collected from suppliers, is
actually collected from gasoline consumers.

f. Repeat parts (a)-(c) assuming that the marginal cost curve is instead given by MC = Q/2. How
does the incidence of the tax compare to what you found in (c)? Why?

Answer 1

First four parts