Chapter 10: Problem 5

What is the impact of taxes on the equilibrium price and output?

Short Answer

Expert verified

Answer: A per-unit tax on a good affects the supply equation, causing a shift in the supply curve. This, in turn, impacts the equilibrium price and quantity demanded in the market. Generally, a tax leads to a higher equilibrium price and a lower quantity demanded, as producers pass on the increased cost due to the tax to consumers.

Step by step solution

1. Understanding Demand, Supply, and Equilibrium

Demand refers to the willingness and ability of consumers to buy a particular good or service, while supply refers to the willingness and ability of producers to offer that good or service. Price and quantity are the two factors that determine the demand and supply in a market. Equilibrium is the point at which the quantity supplied equals the quantity demanded at a specific price.

2. Initial Equilibrium Condition

To find the initial equilibrium, we need to define the demand and supply equations. Assume for simplicity the linear demand and supply functions in the form: Demand: Qd = a - bp Supply: Qs = c + dp where a, b, c, and d are constants, Qd is the quantity demanded, Qs is the quantity supplied, and p is the price. To find the equilibrium, we need to set Qd equal to Qs and solve for the equilibrium price and quantity.

3. Introducing a Tax

Now, let's consider that the government imposes a per-unit tax, t, on the good. This tax will affect the supply equation because the producer has to pay the tax for each unit produced. Therefore, the new supply equation will be: New Supply: Qs = c + d(p - t)

4. Finding New Equilibrium

To find the new equation, we again set Qd equal to Qs and solve for the equilibrium price and quantity: a - bp = c + d(p - t)

5. Comparing Initial and New Equilibrium

By comparing the initial and new equilibrium, we can analyze the impact of the tax on the equilibrium price and quantity demanded. For example, if the price is higher and the quantity demanded is lower in the new equilibrium, it can be concluded that the tax has increased the equilibrium price and decreased the quantity demanded. A graphical representation can further illustrate these changes with demand and supply curves, showing the shift in equilibrium caused by the tax.

6. Conclusion

In conclusion, taxes have an impact on the equilibrium price and output in a market. They cause a shift in the supply curve, which in turn affects the equilibrium price and quantity demanded. Understanding these impacts helps in understanding the broader effects of taxation on an economy and assists in policy formulation.

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