Question

Use the graph below for the following: (LO2)

a. On the graph, demonstrate the effect of a $1 tax on equilibrium quantity and equilibrium price.

b. What is the approximate new equilibrium price of shoes? Why didn’t the price rise by the amount of the tax?   

c. Shade the amount of the tax paid by consumers and label it A; shade the amount of the tax paid by producers and label it B.

Answer 1

a.

b. E isthe  equilibrium before tax is imposed. After imposing tax, prices rise to PB and quantity falls to Q2. New equilibrium price is only the price paid by the buyers in the market for a pair of shoes. Suppliers receive $(PB-1)=$Ps for every pair of shoes, after imposition of $1 tax.

Price does not rise by the amount of taxes as the tax imposed is shared by both the buyers and sellers. Relative elasticity value of demand and supply curves determine the share of the burden of tax on each. Had the supply curve been perfectly elastic, price would have risen by the amount of taxes and consumers had to bear the burden of it completely.

c. A is the amount of tax paid by the consumers, shaded in blue

B is the amount of tax received by the sellers, shaded in red