Question

(a)Explain incidence of direct and indirect taxation using appropriate diagrams. (b)Suppose that the demand and supply for a product sold in a perfectly competitive market are given by the equations:

Qd= 130 – 2P

Qs= -50 + P

(i) What are the perfectly competitive equilibrium price and quantity for this product?

(ii) Suppose the industry that produces this product causes environmental damage valued by the government at 0.5 per unit of output. Determine the socially optimal price and output level for this product.

(iii) What tax should the government add to the price of the product to obtain the socially optimal output level?

(c)Suppose the demand function facing a company manufacturing a particular product (X) is given by

Qx = 62 – 2Px + 0.2M + 25A, where

Px is the price of the product

M is the consumer income, and

A is the amount of advertising expenditure.

If Px is 4, M is 150 and A is 4,

(i) Calculate the amount of X purchased.

(ii) Calculate the income elasticity of demand. Is X a normal or an inferior good?

Answer 1