Topic:
Economic Efficiency, Government Price Setting, and Taxes (Ch 4)
One Long Question (30 points in total):
The demand and supply curves for red pens (used for taking points off from assignments) is given in the figure below.
a. (2 pts) Find the free market equilibrium price and equilibrium quantity.
Consumption tax:
Now assume that a tax of 30 TL per unit is imposed on red pens. Show the effects of this tax on Figure 2 and answer the questions below.
b. (3 pts) Find the equilibrium price and the equilibrium quantity under this tax.
- (4 pts) Find the amount of tax paid by consumers and the amount of tax paid by suppliers for
each unit
of red pens. Explain your answer.
- (4 pts) Comment on the relative price elasticities of demand and supply in this market. To do so do not calculate the elasticities but refer to your answers of part (c) about how consumer and producer is sharing the tax. Briefly explain.
Price-ceiling:
The consumption tax imposed decreased the quantity of red pens bought and sold. Suppose that the government wants to limit the quantity of red pens bought and sold to the
same exact amount
as tax did by using a price ceiling. (There will be no tax this time but a price ceiling, but the price ceiling is going to limit the amount of red pens traded to the same amount as tax)
e. (5 pts) Explain what a price ceiling is and then find the
price-ceiling
that would achieve this aim.
Use the Figure 3 to show the
effects
of this price-ceiling
on
the price and on the amount of good that is bought and sold. Briefly explain your answer.
Welfare comparisons:
f. (6 pts) Compare consumer welfare in the above scenarios of free market equilibrium, price ceiling and consumption tax. To do so shade and label the relevant areas and explain.
g. (6 pts) Compare the total welfare in the above scenarios of free market equilibrium, price ceiling and consumption tax. To do so shade and label the relevant areas and explain.