Tax on Producers and Consumers
Question 1 Figure 1. 1- A tax on Producers a) i) Equilibrium Price and Quantity before tax: 100-10Q = 20 +10Q ? 20Q = 80 ? Q = 4 When Q = 4, P = 60 ? Equilibrium price equals $60 and equilibrium quantity is 4 million ii) Consumer Surplus = ? x 4 x 40 = 80 Producer Surplus = ? x 4 x 40 = 80 iii) An efficient market occurs when total surplus is maximized. This equilibrium of P = 60 and Q = 4 has maximized consumer and producer surplus equally. It is at this point where the marginal cost of production equals marginal benefit.
Question 1 cont. b) i) After imposing a tax of $20, being levied on the producers, the price paid by buyers is $70 and the price received by sellers is $50 per unit of mobile phones sold at the reduced quantity supplied of 3 million. This is illustrated in figure 1. 1 with the shift in the supply curve from S1 to S2. ii) Consumer Surplus = ? x 3 x 30 = 45 Producer Surplus = ? x 3 x 30 = 45 iii) There is a decrease in the total surplus after the implementation of a tax on mobile phones.
A substantial portion of the total surplus has been redistributed to government tax revenue, however, there is a deadweight loss. Marginal social benefits exceed marginal social costs, resulting in inefficiencies within the market for mobile phones. c) Expected Total Revenue = 3 x 20 = $60 million Expected Deadweight Loss = 2 ( ? x 1 x 10 ) = $10 million d) The distribution of real incidence is the amount of burden of a tax shared between the buyer and seller. This proposed tax shares the burden of the $20 equally between buyers and sellers.
The distribution of real incidence on buyers is a $10 rise in the price paid on sellers is the $10 decrease in price received for each mobile phone. e) Elasticity of Demand = Ave. P x ? Q Ave. Q ? P = 65 x (-1) 3. 5 10 = -1. 857142857 ? Elasticity of Demand equals 1. 857 The Elasticity of demand is greater than one which means the demand for mobile phones is elastic. The percentage decrease in the quantity demanded exceeds the percentage increase in price. This tax would mean as there is a 1% increase in price there is a 1. 57% decrease in quantity. There is also a decrease in the total revenue as the price increases. Question 2 | |Printer |Kilogram of Rice | |Thailand |100 |5 | |India |90 |3 | Figure 2. – Thailand’s Production Possibility Frontier Figure 2. 2- India’s Production Possibility Frontier Question 2 cont. | |Printer |Kilogram of Rice | |Thailand |36 |1080 | |India |40 |1800 | c) Points seen in Figure 2. and Figure 2. 2 d) – Thailand’s opportunity cost of producing 1 printer is 20kgs of Rice – Thailand’s opportunity cost of producing 1 Kg of rice is 1/20th of a printer – India’s opportunity cost of producing 1 printer is 30kgs of rice – India’s opportunity cost of producing 1kg of rice is 1/30th of a printer Thailand should specialise in the production of printers as it has a higher comparative advantage. This has been achieved as there is a lower opportunity cost in the production of printers in Thailand compared to India. |Printer |Kilogram of Rice | |Thailand |90 |0 | |India |0 |3000 | Specialisation has lead to an increase in the combined output for both countries. Thailand has increased its printer output by 54 and India has increased rice output by 1200kgs. ) Consumption bundle after trade | |Printer |Kilogram of Rice | |Thailand |42 |1200 | |India |48 |1800 | Consumption points after trade for countries Thailand and India are labeled “H” and “N” in Figure 2. 1 and Figure 2. 2 respectively. Trade has benefited to both countries.
Thailand has increased their consumption bundle with an increase in kilograms of rice from 1080 to 1200 and increased its computers from 36 to 42. India has increased their consumption bundle with their increase in printers from 40 to 48. Question 3 Figure 3. 1- Nuclear Electricity Market a) The equilibrium point e1 is influenced by inefficient outcomes of a subsidy. The subsidy brings about overproduction, represented by the quantity Q1. This overproduction lowers the price, or private costs of the clean up for the company. Marginal costs are increased as the higher production forces inefficient resource allocation. ) If the subsidy is removed there will be an overall increase in the efficiency within this market. The supply will decrease, illustrated in Figure 3. 1 with the leftward shift in the supply curve from S1 to S2. The private cost of nuclear energy production would reflect the true cost of production, including disaster clean-ups. The increase in price can also be seen in Figure 3. 1 with the price from P1 to P2. There would be a consequent decrease in the quantity of nuclear energy and stop the inefficient overproduction and usage of limited resources. ) If the government imposes an insurance levy tax on the power company the cost of a nuclear clean-up will be higher than the cost with a clean-up subsidy but will be lower than costs incurred if the power company had to absorb the entire financial burden. The insurance levy would create a new supply curve, illustrated in Figure 3. 1 with S3, as the reduced cost of a clean-up allows for greater nuclear energy production at a lower price. The quantity increase is seen with the movement from Q2 to Q3 and the decrease in cost of production is seen with the movement from P2 to P3. Question 3 cont. ) The three equilibriums achieved vary in the burden sharing and efficiency of a subsidy, a tax and no intervention in the nuclear energy market. Government intervention with the clean-up subsidy (represented with e1) reduces private costs of production and clean-up. This brings about inefficiencies as the true cost of production, including clean-ups after disasters, is not reflected in price of P1. The reduced cost in this scenario also leads to overproduction and an inefficient quantity of Q1 supplied. The most efficient market where marginal social benefits equal marginal social costs is shown at the equilibrium point e2.
The true cost of production including negative externalities is counted for and there is a subsequent increase in price, as the company passes on costs to consumers, with the removal of a clean-up subsidy (seen with the increase from P1 to P2). The increase in price leads to a decrease in the quantity of nuclear energy demanded and a leftward shift in the supply curve from S1 to S2. The imposition of an insurance levy has decreased the price of a nuclear disaster clean-up as the power company is now relieved of part of the entire financial burdens. This decrease in the price of a clean-up is seen in Figure 3. with the decrease in price from P2 to P3. There is an increase in quantity demanded, seen with the increase from Q2 to Q3 and there is an increase in the supply of nuclear energy production. This new equilibrium e3 is not the most efficient point in the nuclear production market but allows for an increase in demand of the most cost effective energy generation The point e3 would be most beneficial to society as there is an increase in efficiencies with the removal of a government clean-up subsidy yet the power company doesn’t wear the entire financial burdens of further nuclear disaster clean-ups.
There is an increase in the price of nuclear production, however, this point P3 Q3 represents a fairer and more cost-effective way of reducing the costs of future nuclear disasters as less responsibility has fallen on the producers of this energy. Question 4 a) Figure 4. 1 iii) A population decrease will decrease the demand of this inferior good. This is illustrated in Figure 4. 1 with the demand curve shifting to the left from D1 to D2. An increase in the productivity increases the output quantity using the same amount of input.
This increase in supply is seen with the supply curve shift to the right from S1 to S2. The combined decrease in demand and increase in supply has reduced the price of this good from P1 to P2. A new equilibrium, e2, has been formed at the points P2 Q2. Question 4 cont. b) Figure 4. 2 iii) As incomes increase the consumption of inferior goods decrease. This decrease in demand is shown in Figure 4. 2 with the demand curve shifting to the left from D1 to D2 to form the quantity demanded Q2. The increased price of inputs and therefore production costs has reduced the production productivity.
This loss of productivity is illustrated through the leftward shift of the supply curve from S1 to S2. A new equilibrium has been formed at the points P2 Q2. Question 4 cont. c) Figure 4. 3 iii) The demand for inferior goods increases as incomes decrease. This increase in demand is illustrated in Figure 4. 3 with the rightward shift of the demand curve from D1 to D2 and the quantity demanded increase from Q1 to Q2. As the number of firms in the market decrease the price competitiveness influence weakens. Less competition allows for an increase in the price, seen in the shift from P1 to P2.
The combined influence of an increase in quantity demanded (Q1 to Q2) and increase in price (P1 to P2) has formed a new equilibrium point, e2 (P2, Q2), with the shift in the demand curve to the right. Question 4 cont. d) Figure 4. 4 iii) There is a decrease in demand of the inferior good as the consumer preference for this good decrease. The product is used together with a complement product. An increase in the price of a complement product will also decrease the demand of the inferior good. This decrease in demand is illustrated in Figure 4. with the change from Q1 to Q2 and the shift of the demand curve to the left from D1 to D2. This creates a new equilibrium point e2 at the points P2 Q2. Question 4 cont. e) Figure 4. 5 iii) The increased price of a substitute in consumption increases the demand of the inferior good, illustrated in Figure 4. 5 with the demand curve shift to the right from D1 to D2. The supply quantity of the inferior product will decrease as the price of a substitute in production increases. There is an increased ability for the supplier to raise profits from the higher price of the substitute while using the same resources.
This tendency has therefore decreased the supply of the inferior goods, illustrated with the left of the supply curve to the left from S1 to S2. Figure 4. 5 shows how suppliers are only willing to supply the same quantity if there is an increase in price (from P1 to P2). The increase in demand and decrease in supply of this inferior good has resulted in a new equilibrium point e2 at points P2 and Q2. Question 5 a) There is a tendency for consumers to buy products they know which are used by many other people as it influences customer perception of reliability and value.
If a celebrity endorses a product it shows the possible customer how the product has already reached a substantial audience of consumers who are satisfied and willing to show others. b) Inconsistency in consumer behavior can be rationalized under the idea of the endowment effect. The endowment effect makes a person value a personal good higher than it costs to buy. Molly has shown this effect as she is unwilling to accept $50 for her poster even though she knows it costs less than $50 for a replacement. c) Figure 5. 1- Max’s Budget Line i) – Price of Hotdog =$1 Price of Hamburger =$2 ii) Slope: PHAMQHAM + PHOTQHOT = Y ? $2QHAM + $1QHOT = $8 ? QHAM + ? x QHOT = 8/2 ? QHAM = 4 -1/2QHOT ? Slope equals -1/2 There is a negative slope (-1/2) of the budget line. The budget line and the Production Possibility Frontier (PPF) are similar as the curve of each represents the maximum quantity of two products which can be obtained using limited resources. Max’s budget line shows the maximum combination quantity of two attainable products with his limited income while the PPF shows the maximum output of two products with a limited amount of input.