Question

1.  The excise tax levied on producers in an increasing-cost competitive industry will

a. increase the product price more in the short run than in the long run.
b. reduce profits of the firms more in the short run than in the long run.
c. reduce the product price more in the short run than in the long run.

d. reduce total quantity supplied more in the short run than in the long run.

Please provide detailed graphical illustration for the above question and a brief explanation for your answer, using two separate graphs.
(i) Draw a graph showing the changes in market equilibrium, with all the relevant demand and supply curves at the industry level. Please mark the equilibria in the short and long-run.

(ii) Draw a graph showing the changes in firm level equilibrium with relevant cost curves. Provide explanation for the movement of the curves.

Answer 1

1. When excise tax is levied on producers in an increasing-cost competitive industry, it will increase the product price more in the short run than in the long run. Hence, only option a is correct. We can further see the results with the diagram drawn below.

1.

In the above diagram, we have shown the effect of excise taxes on the short run and long run equilibrium in case of industry. In the short run price increases to the amount of tax levied. However, in the long run price increases less than the amount of excise tax.

2. In the above diagram, we have shown the short run and long run cost curves along with respective equilibrium for a firm. Here , it is seen that the short run price change is greater than in the long run. The final equilibrium is attained at point E_t.