Question

Suppose that the for every 10% increase in the price of gasoline, consumers will decrease the quantity demanded by 1%, and suppliers will increase their supply of gasoline by 9%. Next, suppose that there is a $0.50 per gallon tax on gasoline, and after the tax quantity exchanged in the market is 15 billion gallons of gasoline. Given this information, what is the total government revenue from the tax? What is the consumer and producer tax incidence (how much of the tax revenue would have come from consumers, and how much from suppliers)?

Answer 1

Government revenue = tax*(Quantity after tax) = (0.5)*15 = $7.5

Elasticity of supply, Es = Percentage change in quantity supplied/Percentage change in price = 9%/10% = 0.9
Elasticity of demand, Ed = Percentage change in quantity demanded/Percentage change in price = -1%/10% = -0.1

Tax burden on consumers = Es/(Es+Ed) = 0.9/(0.9+0.1) = 0.9/1 = 0.9
So, tax revenue paid by consumers = 0.9*(Government revenue) = 0.9*(7.5) = $6.75

Tax burden on producers = Ed/(Es+Ed) = 0.1/(0.9+0.1) = 0.1/1 = 0.1
So, tax revenue paid by producers = 0.1*(Government revenue) = 0.1*(7.5) = $0.75

(Note: we use absolute value of Ed.)

answered by: anonymous