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Tax impact

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Suppose all firms in a perfectly competitive market structure are in long-run equilibrium. The demand for the firms' product increases. Initially, price and economic profits rise. Soon afterward, the government decides to tax most (but not all) of the economic profits, arguing that the firms in the industry did not earn them - the profits were simply the result of an increase in demand. What effect, if any, will the tax have on market adjustment?

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Solution Summary

The solution looks at the impact tax has after an increase in demand for product.

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Let's assign three stages to this problem:
Stage 1 = Conditions before the demand increase  Perfect competitive market structure and long-run equilibrium.
Stage 2 = Conditions after the demand increase but before taxes are ...

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