Chapter 6, Problem 6.4SC

To determine

The impact of the Federal taxes on the supply curve of the good taxed.

Concept Introduction:

Supply curve- The supply curve abides by the law of supply establishing a direct relationship between the price and the quantity supplied assuming ceteris paribus. If however, factors other than price change due to changes in ceteris paribus conditions, like technology, labor productivity, taxes etc, the supply curve shifts inward or outward.

The following graph illustrates the market for a product where the market interaction of demand and supply determine the equilibrium price at P1 and equilibrium quantity at Q1. A tax increases the cost of production of the producer. The increased cost causes the supply to decrease as suppliers sell less. This causes the supply curve to shift leftwards from S1 to S2 as shown in the graph below.

The leftward shift in the supply is equal to the amount of tax imposed as shown above. This is because for each unit of the output the tax is added to the price. The new equilibrium is established at a higher price and a lower quantity bought and sold. The higher prices are shared among the buyers and sellers depending upon the elasticity of demand for the good in the market. Thus, the incidence of tax is shared among the producers and consumers.