Question

assume that a monopoly firm has a linear demand curve and a constant marginal cost curve. Graph this firm's optional output choice before and after a per-unit excise tax is placed on the output. Does the equilibrium price rise by as much as tax?

Answer 1

A monopolist maximizes profit by equating Marginal revenue (MR) with marginal cost (MC) curves. When per-unit excise tax is imposed, MC effectively increases and therefore, after the tax, equilibrium price is higher and quantity is lower. But increase in equilibrium price is not equal to the amount of unit tax.

In following graph, D, MR & MC1 are demand, marginal revenue and pre-tax marginal cost curves. Initial equilibrium is at point A with equilibrium price P1 and quantity Q1. As the excise tax increases MC1 to MC2 (MC2 - MC1 = t = Unit tax), new equilibrium is at point B with higher price P2 and lower quantity Q2. However, increase in price is less than amount of units tax since (P2 - P1) < t.