Kennedy King College Market Failure Elasticities and Indirect Taxes Questions

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Economics

City Colleges of Chicago Kennedy King College

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Running Head: MARKET FAILURE, ELASTICITIES AND INDIRECT TAXES

Market Failure, Elasticities And Indirect Taxes
Institution Affiliation
Course
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1

MARKET FAILURE, ELASTICITIES AND INDIRECT TAXES
Assessment task 2 – Part 2 - Market failure, elasticities and indirect taxes (20%)

Question 1
Consider product Y with the following demand and supply functions:
Qd = 100 – 2p
Qs = -20 + 4p
The government has not currently imposed an indirect tax on product Y. However, the
production and consumption of product Y is considered undesirable. Subsequently, the
government imposes an indirect tax on the product. The consumer pays a price of $24
per unit after tax. Assume the product has an income elasticity coefficient of +1.5.
Use the above information to undertake the following:
Draw a demand and supply graph illustrating the market for Product Y both before
and after the imposition of the indirect tax.
Qd= 100-2p
Qs=-20+4p
At equilibrium, Qd=Qs
Hence, 100-2p= -20+4p
; -2p-4p=-20-100
; -6p=-120
; P*= $20
Substitute P into Qd to get equilibrium quantity;
Qd= 100- 2(20) = 60
Q*=60

MARKET FAILURE, ELASTICITIES AND INDIRECT TAXES

Before indirect tax;
P= $20
Q= 60.
After imposition of indirect tax of 20%
120/100x20=24
P=$24
Qd=Qs= 100-2(24) =56 or-20+4(24) =56
Qd=Qs=56
Demand curve;
Q intercept, When p=0
Qd=100-2(0) =
Q=100
P intercept when Q=0
0= 100-2p
P= 50
Supply Curve;
Q intercept when P =0
Qs= -20+4(0) = -20
Q= 20
P intercept when Q= 0
0= -20+4p= 5.

P=5

MARKET FAILURE, ELASTICITIES AND INDIRECT TAXES

Calculate the per unit tax.
Per unit tax= price before tax-price after tax
24-20= 4
Tax= $4 per unit
Alternatively,
Tax rate= 20%
Hence, 20/100x 20= 4
Tax= $4 per unit.

MARKET FAILURE, ELASTICITIES AND INDIRECT TAXES
Calculate and explain consumer surplus, producer surplus and deadweight loss before
and after the imposition of the indirect tax.
Consumer surplus is defined as the difference between the price buyers pay for a product
and the price, they are willing to pay (Economics Online, 2020).
Before indirect tax;
Consumer surplus= 1/ 2x Qd x change in price
1/2x60 x (50-20) = 900
Consumer surplus after indirect tax
½ x 56 x (50-24) =728
Producer surplus refers to the difference between the amount a producer would be willing to
receive for a given quantity of a product supplied and the much they receive by selling the
good at the market price. On a supply curve it is shown by the difference between the
production cost and the market price (Economics Online, 2020).
Before indirect tax;
½ x Qd x (total revenue-total cost)
½ x60 x (20-5) = 450
Producer surplus after indirect tax
½ x 56 x (20-5) = 420
Imposition of tax has reduced both the consumer and producer surplus. The larger share of
the tax burden has fallen on the buyers.

MARKET FAILURE, ELASTICITIES AND INDIRECT TAXES
Deadweight loss, (also referred to as excess burden) is the cost caused by market failure
which is experienced when demand and supply of a product are out of the equilibrium. It is
the loss caused by imposition of tax leading to raised prices which inhibit consumers from
buying a good.
Calculate and interpret the own price elasticity of demand using the arc method.
Price elasticity of demand
Price elasticity of demand is the responsiveness of demand of a product to the percentage
change in its price. It is the percentage change in demanded quantity, divided by the
percentage change in the product’s price (Cordes et al., 2005, p. 102).
Arc Ed=

% [(Qd2-Qd1)/midpoint Qd]
%[(P2-P1)/midpoint P]

Therefore, % [(56-60)/58]
% [(24-20)/22]
= |-0.38|= 0.38 (Inelastic)
Calculate and explain the burden of the tax. Discuss the relationship between the
burden of the tax and the coefficient of elasticity calculated in part iv.
The tax burden the reduction in the profits enjoyed by the producers or the consumer
surplus. It is as a result of tax imposition by the government. The elasticity of a product's
demand and supply curve determines where the tax burden falls in the market. It can either be
on the consumers or the producers. The demand for product Y is inelastic, which is implies
tha...

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UIUC

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