Purchase Solution

# Tax policy

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1) Suppose that a market is described by the following supply and demand equations:
Qs= 2P
Qd= 300-P

a. Solve for equilibrium price and the equilibrium quantity.
b. Suppose that a tax of T is placed on buyers, so the new demand equation is
Qd= 300- ( P+T)

Solve for the new equilibrium. What happens to the price received by sellers,
The price paid by buyers and the quantity cost?

c. Tax revenue is T x Q. Use your answer to part (b) to solve for tax revenue as a function of T.
Graph this relationship for T between 0 and 300.
d. The deadweight loss of a tax is the area of triangle between the supply and demand curves. Recalling that the area of a triangle is 1/2 x base x height, solve for deadweight loss as a function of T.
Graph this relationship for T between 0 and 300. (Hint: Looking sideways the base of the deadweight loss triangle is T and the height is the difference between the quantity sold with the tax and quantity sold without tax.)
e. The government now levies a tax on this good of 200\$ per unit.
Is this a good policy? Why or why not? Can you propose a better policy

##### Solution Preview

1) Suppose that a market is described by the following supply and demand equations:
Qs= 2P
Qd= 300-P

a. Solve for equilibrium price and the equilibrium quantity.

When Qs = Qd we have 2P = 300 - P.
This yields 3 P = 300 and P = 100.
Quantity is then 200.

b. Suppose that a tax of T is placed on buyers, so the new demand equation is
300- ( P+T)

Solve for the new equilibrium. What ...

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