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Principles of Microeconomics

7th Edition
N. Gregory Mankiw
ISBN: 9781305156050

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Principles of Microeconomics

7th Edition
N. Gregory Mankiw
ISBN: 9781305156050
Textbook Problem

In a supply-and-demand diagram, show how a tax on car buyers of $1,000 per car affects the quantity of cars sold and the price of cars. In another diagram, show how a tax on car sellers of $1,000 per car affects the quantity of cars sold and the price of cars. In both of your diagrams, show the change in the price paid by car buyers and the change in the price received by car sellers.

To determine
The impact of tax.

Explanation

Tax is the unilateral payment from the people to the government. Tax is the main source of income of the government which can be used for carrying on the public expenditure of the government. The efficient tax is the tax which has the lowest excess burden compared to the revenue raised from the tax. The excess burden is known as the deadweight loss. Thus, the tax is efficient when it imposes the least excess burden relative to the revenue raised through it.

When there is no tax imposed in the economy, the economy will be in its equilibrium where the demand curve (D1) and the supply curve (S) intersect with each other. The intersection will determine the equilibrium price and the quantity demanded in the economy. At this point, there will be no excess demand or excess supply in the economy. When the tax is imposed on the commodity, it will impose a higher price of car on the buyers and as a result of the tax, the demand will shift leftwards or downwards denoting the decline in the demand for cars. This can be denoted with the graph as follows:

When there is no tax, the economy faces the demand curve D1 and the supply curve S, and the equilibrium is defined at their intersection point. So, the economy has an equilibrium price of P1 and the equilibrium quantity demanded of Q1. When tax is imposed on consumers, price increases by the amount of the tax. Since the tax amount is $1,000, the price will be higher than the producer receiving price, and the tax amount will be equally distributed amongst the buyers and the sellers. Thus, the new price will be P2 + $1,000, which will be higher than the equilibrium price. As a result, the demand curve will shift downwards to D2, which will lead to lower quantity demanded at Q2...

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