Question

Assume the beer industry is perfectly competitive, Senator X claims that if the government imposes an excise tax on beer, consumers will not be affected because the firm’s will pay the tax? Is he correct in the short run? What about the long run? What assumptions do your answers depend on?

Answer 1

Senator X is not entirely correct. An exice tax will imply that per unit cost will increase so that each firm will experience an upward shift in the average cost and marginal cost. With unchanged price and increased per unit cost, each firm now produces more and bear an economic loss.

He is correct that in the short run because no firm is leaving the industry but each is operating at a loss, the price is not changed and firms are paying the entire tax, But in the long run as firms find themselves unable to produce at a loss, they leave the industry and this shifts the market supply to the left. This shift will raise the market price. Assuming that demand and supply are relatively elastic, such a shift will not pass the entire tax on buyers nor it will be paid entirely by sellers. It will be shared by them.