Sunday, April 5, 2015

2014 Microeconomics FRQ #3

2014 Microeconomics FRQ #3

You can. 
Yes. Yes, you can. 
I think so.
Now, you must think so.

3. Assume that gasoline is sold in a competitive market in which demand is relatively inelastic and supply is relatively elastic.
(a) Draw a CLG of the gasoline market. On your graph show the equilibrium price and quantity of gasoline, labeled Pe & Qe.

(b) Suppose the gov't imposes a $2 per unit tax on the producers of gasoline. On your graph from part (a), show each of the following after the tax is imposed.
(i) The price the buyer paid, labeled PB.
So, the government imposes a $2 dollar tax, on producers. Producers supply the good so the price of the good has to include the tax,, therefore the (S + tax) shifts up by the $2 dollar amount.

(ii) The after-tax price received by sellers, labeled PS.

Remember, that the seller has to send $2 of what he receives to the government, and the distance between S & S + tax is the $2 dollar amount.

(iii) The quantity labeled, QT.
(C) Using the labelling on your graph, explain how to calculate the total tax revenue collected by the government.

The total tax revenue can be found by taking the amount of the tax ($2) and multiplying it by the new (after tax) quantity sold.

So, $2 x QT

or, (PB - PS) x QT  

or , TAX x QT

(D) Will the tax burden fall entirely on buyers etc etc etc etc...

The tax buyers will fall more on buyers and less on sellers because the demand curve is more inelastic than the supply curve.

If the demand curve is inelastic (think drugs) then consumers will have less substitutability and will not change their buying patterns (relatively) with the increase in price.

Therefore, even when the price goes up,, demand for the good does not decline as much as the price rise.

Look at the graph, the wedge between PE and  PB (buyers wedge) is greater than the wedge between PE and PS (sellers wedge).

The wedge is the amount of tax incidence on each party,, buyer or seller.