How the imposition of a Pigovian Tax could alter the equilibrium in the market

timer Asked: Sep 29th, 2013

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Question 1 A newly formed dance group, Macq Mega Max has released a single, Economexy. Assume that the download price for their new single is $1.20 and the number of downloads per day world-wide is 5,000. What will happen to the market for this single if the following four events occur: (i) The population of dance music fans decreases AND the productivity in the music production increases. (ii) Dance fans switch away from dance music to R&B music AND the price of MP3 players increases. (iii) The number of other dance singles decreases AND income increases. (iv) One of the artist’s in Macq Mega Max is rumoured to have died AND the download price of rival group’s Techno New Syd West’s single, Bang, decreases substantially to $0.20 . Each event (i, ii, iii and iv) occurs independently (ceteris paribus). For each of the following events, explain what will happen to the equilibrium price and the equilibrium quantity for the download of Economexy. For each part, you must: • Draw an appropriately labeled diagram, • Show the adjustment process from the original to the new equilibrium, • And a detailed written explanation of this adjustment process. Question 2 A. Show how the imposition of a tax on either the buyers or sellers in a market has the same effect on equilibrium price and quantity. Make sure you use appropriate diagrams in your answer. B. Assume that the demand and supply curves in a market for cigarettes are represented by the following equations: P = 200 – 0.5Q and P = 0.5Q. The government then decides to impose a tax of $20 per unit on sellers in this market. Assume that the market is already efficient prior to the imposition of the tax. a. Calculate the equilibrium price and quantity before the imposition of the tax, and draw the demand and supply curves in this market, showing all relevant information. b. Show what the tax does to the market in the diagram drawn in (i) c. Calculate the equilibrium price and quantity after the imposition of the $20 per unit tax. d. Calculate the tax revenue collected by the government, and the tax incidence of this tax on buyers and sellers. Question 3 Assume the production of coal involves the generation of a negative externality. A. Explain how the equilibrium level of output would be determined in the market for coal, assuming no attempt is made to internalise the externality. Is that equilibrium efficient? Use a diagram(s) as part of your explanation. B. What is a Pigovian Tax? Explain how the imposition of a Pigovian Tax could alter the equilibrium in this market. How does the tax impact on the efficiency of this market? Use a diagram(s) as part of your answer. You are free to augment the diagram you used in (a) in your answer to (b). C. What other solutions could be used to remedy this negative externality? You do not need to describe these remedies in detail. Question 4 Assume that there are two categories of goods: protein shakes and all other products. A. Show using diagrams how a consumer’s demand curve for protein shakes can be derived from an indifference map and a budget constraint diagram. Make sure you explain your answer in detail. B. Using a different set of diagram/s deconstruct the price effect into the substitution effect and the income effect. Take note to define each effect.

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