Question

Suppose a market with supply function X=p/2, where X is quantity and p price. The demand is infinitely inelastic at X=5.5. The government establishes an excise tax of 1€ per unit. The consumers are supposed to pay the tax.

What is the price received by sellers and what is the after-tax price paid by consumers

Select one:

a. price sellers=11; price consumers =10

b. price sellers=10; price consumers =11

c. price sellers=12; price consumers =11

d. price sellers=11; price consumers =12

Answer 1

Ans Option d

Equilibrium price before tax,

Supply = Demand

p/2 = 5.5

=> p = $11

After the tax is imposed, the burden of the tax on the consumer is given by the formula,

Burden = Elasticity of supply/ (Elasticity of supply + Elasticity of demand)

=> As demand is infinitely inelastic, so, elasticity of demand = 0

=> Burden = 1 or 100%
So, entire tax is paid by the consumers, thus, price paid by the consumers is $12 and recieved by the sellers is $11

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