Question

1. Market demand and supply for a commodity are given by the following equations:

Demand: X = 30 – (1/3) P
Supply: X = -2.5 + (1/2) P where X= quantity (units), and P=price per unit ($)

Suppose that the government is planning to impose a tax on this commodity and considering the following two options:

Option 1: A unit tax of $15
Option 2: An ad valorem tax of 20%

1. a) Find the tax incidence on buyers and producers, and the tax revenue of the government under each the two options

2. b) Compare the two options in terms of their welfare costs

Answer 1