Question

Consider the market for hiking boots. This market can be represented by the following supply and demand equations: Q=100–2P (demand) and Q= –20 +P (supply)

a. Suppose that a tax of $5 is imposed on each pair of boots. With the tax of $5 , find the price that consumers pay, the price that firms receive, and the quantity exchanged.

b. In which case—relatively elastic demand or relatively inelastic demand—would tax revenues be higher? Illustrate graphically.

Answer 1

Part (A)

tax of $ 5 is imposed on the market

Part (B)

If demand is inelastic, a tax will cause only a small fall in demand. Most of the tax will be passed onto consumers. When demand is inelastic, governments will see a significant increase in their tax revenue.

If demand is elastic, then an increase in price will lead to a bigger percentage fall in demand. In this case, the producer burden is greater than the consumer burden. The tax will be more effective in reducing demand, but less effective in raising revenue for the government