 |  Principles of Microeconomics, 1st Canadian Edition Robert H. Frank,
Cornell University
Ben S. Bernanke,
Princeton University
Lars Osberg,
Dalhousie University
Melvin Cross,
Dalhousie University
Brian MacLean,
Laurentian University
Efficiency and Exchange
Graphing ExercisesExtending the Text Economic Naturalist 7.2 asks what the impact of a $100 tax on automobiles will be in the long run. The conditions of the exercise are that inputs can be obtained in unlimited quantities at fixed market prices and the cost to produce one automobile is $10,000. In this case the supply of cars is infinitely elastic (perfectly flat in P, Q space). The $100 tax simply pushes the cost of producing an automobile up from $10,000 to $10,100 and, for any fixed down-sloping demand curve will simply increase the price of the car by the full $100. |
| | 1. | Notice that the equilibrium price for cars, in this case, is $10,000. Enter an Excise Tax of $100 in the box above the graph. What happens to the equilibrium price and quantity of cars sold?
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| | 2. | What would happen to the price and quantity if the demand for cars were more elastic (more sensitive to changes in price)? Click on the Reset button and then change the Demand to Relatively Elastic by clicking on the "<<D" button to make demand flatter, and repeat the exercise of adding in a $100 excise tax.
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| | 3. | What would happen under this scenario if the supply, rather than being flat, were upward sloped? That would occur if the original condition that "inputs can be obtained in unlimited quantities at fixed market prices" did not hold. In other words, as more cars are produced the cost per car of producing them rises. Click the Reset button and then adjust the supply curve to "More Elastic" by clicking on the "S>>" button.. Now repeat the exercise by adding in a $100 excise tax, as before.
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| On Your Own: How are the costs of taxes distributed?
Continuing with the car example from above, what is the impact of a tax on the well being of the individuals involved? How are the gains and losses distributed? What is the difference between a tax on producers and a tax on buyers? To address questions of these types we will need to look into consumer and producer surplus, and into the notion of deadweight loss.
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| | 4. | To begin your analysis, open a new window containing the interactive supply and demand graph or, if the window is already open, click the Reset button. Now click the Surplus Measures button to open the right side of the applet. From this starting point, notice the surplus available to be divided up and how the division takes place between the buyers and the sellers. (You may want to return to your book and refresh your memory about market surplus.) Now, if we impose a tax on the sellers, say $150 per car, what will be the impact on price, quantity, market surplus and the division between buyers and sellers?
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| | 5. | How does the outcome above differ if the supply is not perfectly elastic? Reset the applet, click on the "S>>" button so that the supply is "More Elastic" and repeat the exercise above.
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| | 6. | Suppose we go to the other extreme, a perfectly inelastic demand. In order to examine this situation, reset the graph and then click on the "S>>" once to cause the supply curve to be "more elastic". Then click on the "D>>" button until the demand curve is perfectly inelastic. Now repeat the exercise above, except this time make the excise tax be only $100. How does the elasticity of demand affect the distribution of the surplus and the amount of deadweight loss from a tax?
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| Questions to Think About... - If you were in charge of a taxing agency, and you wished to raise the maximum revenue with the least impact on the citizens of your area, how would you incorporate the notion of elasticity of supply and demand into your decisions about what product to tax, and whether the tax should be on the seller or on the buyer?
- These questions have dealt with lump sum or per-unit taxes. How would a percentage tax, like a sales tax, change the analysis?
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2003 McGraw-Hill Higher Education