Question

The government has increased Vat on some commodities in order to raise revenue. The market for commodity x was at equilibrium before tax at shillings 50 per unit sold and the quantity was 5000 units. Suppose own price elasticity of demand is 0.6 and the elasticity of supply is 1.1. After the government announced tax measures the new price increased to shillings 70 per unit. Calculate the equilibrium price and quantities after tax.

Answer 1

Before tax the price was shillings 50. After tax the price is shillings 70 per unit. Hence price consumers face increases by shillings 20. In percentage terms, price is increased by 20/50 = 40%

Increase in price in % = % change in Q / (demand elasticity + supply elasticity)

40% = % change in Q /(0.6 + 1.1)

% change in Q = 68%

Thus, quantity will decrease by 68% from 5000 units to 1600 units. Thus, new price (paid by buyers) is shillings and new quantity is 1600 units.