Chapter 13: Government intervention - indirect taxes (1.3) · 2016. 5. 24. · Chapter 13: Government intervention - indirect taxes (1.3) Section 1.3, Chapters 13 – 15, deals with

Chapter 13: Government intervention - indirect taxes

(1.3)

Section 1.3, Chapters 13 – 15, deals with the various methods governments use to influence supply and demand on markets. We start off by looking at taxes on expenditure.

• Why governments tax goods I always ask my students the question my micro teacher at university asked us: “Why do we tax alcohol more than we tax ice cream?!” There are two answers. The first is that governments levy (= put, apply) indirect taxes as a method to create tax revenue. Alcohol will have far lower price elasticity of demand than ice cream so quantity demanded will fall proportionately less for alcohol than ice cream, which means government revenue will be greater. The second reason is that government commonly try to dissuade (= discourage) the consumption of goods which cause damage to society (see Chapter 17). Alcohol causes a great deal of negative effects for non-users, such as accidents due to drunk driving and domestic violence.

• Specific tax (per unit tax) A specific tax on expenditure is a tax on each unit sold/consumed – which is why such taxes are often referred to

as unit taxes. This means that the rate of tax per unit is independent of quantity or price. The most common unit

taxes are taxes on petrol (€ per litre); on alcohol (€ per litre); and tobacco (€ per kilo or packet). Import taxes are

also frequently unit taxes, such as € per tonne of wheat/ per automobile/ per cubic metre of liquid gas. Unit taxes

are thus flat rate taxes, which refers to the tax being the same on each unit. A €2 unit tax a bottle of wine is the

same tax on both a €5 bottle of Cote du Merde as on a €50 bottle of 1964 Rioja Gran Reserva.

Assume that government levies an expenditure tax of €2 on, say, cotton shirts. This method of taxation is basically

Definition: Specific tax A specific tax is the same amount on each unit sold, such as an amount

per litre or kilo. It is therefore often called a unit tax.

Key concepts:

• Why governments tax goods

• Specific tax (per unit tax)

• Ad valorem tax

HL extensions

• Incidence of tax; PED and government revenue

• Incidence of tax; PES and government revenue

• Plotting linear supply and demand curves o Consumer and supplier surplus o Deadweight loss

the same as government telling producers that at whatever price they sell the shirts, for each unit sold €2 must go

to the tax authorities. Assume that the original retail price (= final consumer price) of an Alligator Shirt is €10 and

that the seller buys the shirts for €5. Now, the question is, the suppliers know that however many shirts they sell,

each one represents a ‘tax debt’ to the government – so by how much do they raise the price in order to pay this

coming debt?!

Theoretically, producers could still sell the shirts at €10 and simply be satisfied with a gain (gross profit in

accounting-speak) of €3 per shirt rather than the previous €5. Or, they could raise the price by the same amount as

the tax, to €12, in order to keep the same profit margin. The main issue here is how consumers react – e.g. their

sensitivity to an increase in price. The responsibility of the final price is in the hands of the producer, which is

basically the producer thinking “How much of the tax dare I levy on the consumer?!” or “How much should I

allow my costs to increase by?” This increase in costs for producers shifts the supply curve to the left.

Figure 13.1 shows how the €2 expenditure tax decreases supply (S0 to S+tax) by the amount of the tax. The tax can

be seen by the vertical distance between S0 and S+tax – at every level, the difference between supply curves is €2.

The tax has the following effects:

• The price increases (form €10 to €11) and the quantity demanded falls (from 100,000 shirts to 80,000

shirts)

• Half of the €2 tax is paid by the consumer and half is paid by the producer. (This is the incidence of tax –

a HL concept done further on.)

• Total government tax revenue is €2 x 80,000 shirts; €160,000

• Producer revenue decreases from €1 million (€10 x 100,000) to €720,000 (€9 x 80,000) per month

• Consumption decreases by 20,000 shirts per month and consumer spending goes from €1 million (€10 x

P (€/shirt)

Q/t (1,000s shirts/month)

Fig. 13.1 A specific tax on shirts

D

9

80 100

S0

10

11

Tax/unit = €2

S+tax

The supply curve S1 shifts parallel to the original supply curve.

Total govt tax revenue: €2 x 80,000 shirts = €160,000

100,000) to €880,000 (€11 x 80,000).

My home country of Sweden has the highest overall tax pressure in the world at around 54% of GDP.

Income tax is a major part of government revenue and of course a burden on households. My Swedish

students were well aware of the incentive for parents to hire black market labour in, say, re-doing the

kitchen or adding on to the garage. Several asked during the first edition of this book that I include in the

next edition what I did on the board in class, namely illustrate the incentive for me to join the black

market for labour during a summer when I was a poor student.* (Note that while I am using the diagram

below to illustrate a personal story, it is equally re-applicable to the aggregate, i.e. the labour market as a

whole.)

Outside the box: income tax and black markets

The income tax creates a “wedge” (= block) between what I receive as a labourer (PLnet) and what my employer pays (PLgross). My incentive to work (e.g. SL) decreases from SL0 to SL1 – and my employer’s quantity demanded for my labour decreases from QL0

to QL1. The possible black market arises anywhere between PLnet and PLgross – that’s where my employer and I negotiated terms! QL/t (hours/year)

DL

* To anybody in the Swedish tax dictatorship bureaucracy who happens to see this; we are well

past the statute of limitations! Just give me my pension fund and I’ll be on my way.

QL0

(SEK100) PL0

SL

(SEK130) PLgross

QL1

PL (= wage rate, SEK/hour)

SL+tax

(SEK70) PLnet

Basically what happened was that a friend of mine who ran a large retail store needed help one summer stocking goods on shelves and packaging goods for customers. (SEK = Swedish crowns – and I don’t remember the wages so I’ve indexed the values.) “Look Matt, if I pay you officially, then I’ll be subject to labour taxes and social security payments. Your wage of SEK100 per hour will cost me an additional SEK30. On the SEK100 you will pay 30% in income tax. In other words; your net wage of SEK70 will cost me SEK130. Now, what if we split the difference and cut out the “middleman” in the government tax office…” It didn’t take a degree in rocket surgery to figure out that by avoiding the taxman, my employer could save

SEK30 and I could increase my wage by SEK30. I would be willing to work more hours (QL0) and he

would be willing to pay for it. Everybody wins…except, of course, the tax office. Oh, and the people who

benefit from public and merit goods; 9 million Swedes.

Fig. 2.2.31 Black market labour

• Ad valorem tax A tax based on the base value of a good is just like any percentage-based tax. For example, a 30% income tax

means you pay £30 on an income of £100, £60 on an income of £200 and so forth. The same effect is evident

when levying an ad valorem tax (value-added tax or VAT); the tax per unit will increase as the price of the good

rises.

Figure 13.2 shows the effect of VAT on our Alligator Shirts. Assume that a VAT of 20% is imposed at an

equilibrium price of €11 and a quantity of 80,000. The supply curve shifts disproportionally, from S0 to S+VAT,

since the higher the price, the larger the price increase of the 20% VAT.

Definition: Ad valorem tax An ad valorem tax (value added tax) is based on the base value (price) of a good sold, and as it is a percentage the amount of tax per unit will increase as the base value increases.

At higher prices the ad valorem tax shifts the supply curve higher, increasing the distance between S0 and S+vat.

At the new equilibrium price of €12, the 20% VAT renders a €2 tax per unit.1 In other respects we have the same

type of outcome as before; the price increases from €11 to €12, quantity demanded decreases from 80,000 to

60,000 shirts, producers’ revenue is €600,000 (€10 x 60,000) and consumer spending is €720,000 (€12 x 60,000).

1 A brief footnote on my examples above (figures 13.1 and 13.2). Many of you are probably wondering what lunacy possessed me to put first a unit tax – and then a value added tax on top of that! The example of ‘taxing a tax’ looks absolutely bizarre, silly and impractical. Quite naturally, this is exactly what is done in many countries. Petrol prices in Europe, for example, will be comprised of around 80% tax. Say that the base price of a litre of petrol is €0.2 to which a €0.6 unit tax (per litre) is added, and then topped off by a 25% VAT. This brings the final price to €0.8 + 25% = €1.

P (€/shirt)

Q/t (1,000s shirts/month)

Fig. 13.2 Incidence of an ad valorem (VAT) expenditure tax on shirts

D

10

60 80

11

S0

The supply curve S+VAT does not shift parallel to S0 since the VAT results in a higher

tax/unit at higher prices.

S+VAT

New equilibrium; tax/unit

is 0.2 x €10 = €2

12

Tax/unit price 0f €10; 0.2 x €10 = €2

Total govt tax revenue: €2 x 60,000 shirts = €120,000

Exam tip; clarity in diagrams

Note in figures 13.1 and 13.2 how I “break out” the tax arrow and refer to it clearly as “Tax/unit”. When we add in additional economic concepts, such as welfare loss triangles (Chapters 17 and 18), you will make your examiner’s life easier by keeping all points, arrows and distances clearly distinguishable. Basically, as I tell all my people; “Do you want to yank the chain of the person grading your exams?” I recommend that you do the “break-out the tax arrow” (or something like it) in all your diagrams and basically make it a “knee-jerk” (= natural) reaction. During exams you will be stressed out and that’s when you get messy/unclear – and lose marks as a result. One of my karate teachers, Kawasoe sensei, was very clear that what you practice in the dojo (= karate gym) is what you do in a stressful situation (= getting attacked*). He was right. I am asking you to make neat and clear diagrams a part of your “econ karate nature” so that when the exam questions assault you, your neatness-reaction is second nature. * (Rory; this is a footnote. MS Word won’t let me include it as a footnote at the bottom of the page.) You think I’m making this up? Listen, I live on coffee, sugar, nicotine and stress. Basically I’m pretty wired. When I’m was out running in “bad areas” in Mexico I was frequently attacked by wild dogs – carrying any number of diseases which are probably not even in the books. To date I’ve palm-smacked and front-kicked at least three dogs into the brush. I sent a mental note of thanks to Kawasoe sensei every time. Oh, after a while, fearing getting some nasty disease via physical contact with the mutts, I had the workers in school make me a nice pair of nunchuks. I got more exercise swinging the nunchuks at dogs than

from the actual running.

Some movies should be obligatory viewing for politicians. The Swedish government would have done well to watch “The Untouchables” (about the infamous Al Capone and organised crime’s rise to power during the ban on alcohol in America in the 1930’s) prior to increasing tobacco taxes in 1997. Here’s what happened. In August of 1997, the Swedish government raised the tax on tobacco by 18% as part of a health-drive and possibly to increase tax revenue. Nobody actually seems to know. In any case, cigarette consumption plummeted by 20% which would seem to belie the 0.45 PED for tobacco in table 9.1 in Chapter 9. What the Swedish government did not seem to realise, yet every single one of my IB1 students did, was that there were indeed any number of substitutes available for cigarettes which would explain the massive 20% fall in consumption, pointing instead to a PED of 1.1. It turned out that the Baltic states, Russia and Poland had an abundance of cheap black market cigarettes and also a number of budding capitalists who saw an opportunity to make a good deal of money. “Duh!” said all my IB1 students who snidely predicted exactly what was to happen! Figure 13.3: The increase in tax lowered the legal quantity demanded from Q97 to Q98 raising the official market (O.M.) price of cigarettes from P97 (point A) to P98 (point B). Figure 13.4: An immediate surge in demand for black market cigarettes was the result, where demand rose from DB.M.97 to

DB.M.98 and quantity went from Q’97 to Q’98 (point B’).

P98

PO.M./pack (SEK)

SB.M.’97-‘98

DOM ‘98-‘99

Q/t (packs/month on O.M.)

Figure 13.3 Cigarettes – official

market (O.M.)

At each price

level, the black

market price is

lower than the

official market

price.

DOM ‘97

Q98 Q99 Q97

P97

P99

P’98

PB.M./pack (SEK)

DB.M. ’98

Q’97 Q’98

DB.M. ’97

Q’99

P’97

P’99

DB.M. 99

SB.M.’99

Figure 13.4 Cigarettes – black

market (B.M.)

Secondary effects: During the period of 1997/98, demand for official market cigarettes had become more elastic, due to the availability of substitutes. By the time the tax on cigarettes was lowered, demand had decreased to DOM 98-99 and become more price elastic due to the increase in available substitutes. The effect was that quantity demanded didn’t return to the previous level, but only to Q99 (point C).The reason for this was that the supply of black market cigarettes had increased markedly, from SB.M.97/98 to SB.M.99. Black market PES increased also, since by this time the black marketers’ supply chains and stocks had been firmly established. The lower tax did have an effect on demand for illegal cigarettes, as shown by the shift of DB.M. 98 to DB.M. 99, yet the black market equilibrium did not return to the previous level (point B’)but was established at point C’. Throughout the period, the black market price was kept firmly below the official price level, making it possible for black marketers to remain entrenched (= established) on the market.

(Rory: please be careful with all the points and dotted lines here! Took me ages to align it all. Might have to

enlarge this!)

B

C’

B’

A’

C SO.M. ‘97

Q/t (packs/month on B.M.)

SO.M. ’98 + tax

A

SO.M. ’99 lower tax

A Case of stupidity Study; Tobacco tax in Sweden1997/98

HL extensions

• PED – the incidence of tax and government revenue Let us compare two goods, one with low PED and one with high PED; petrol and oranges. This time, we extend

the analysis from how consumers and producers will be affected by the tax to how government revenue will differ.

Figure 13.5 below shows supply and demand for the two goods, and we assume rather unrealistically both goods

to have an initial price of ¥100 (Japanese Yen) and quantity of 100 (basically, I am indexing prices and quantity).

A specific tax of ¥50 is put on both goods,2 raising the price of both goods – but the comparison pretty much ends

there.

2I will limit myself to flat rate taxes in showing incidences of tax. There is simply no real benefit in using an ad valorem

tax to show the burden of tax.

Q/t (millions packs/month)

Dpetrol

P (¥/pack)

100

140

80 100

90

Tax = ¥50 per pack

a) Cigarettes

b) Oranges

S+tax

S0

Q/t (millions kg/month)

Doranges

P (¥/kg)

100

120

60 100

70

Tax = ¥50 per kg

S+tax

S0

Total incidence of tax. Govt. tax revenue; ¥50 x 80 mn = ¥4,000 mn

Incidence of tax on consumer; ¥40 x 80 mn = ¥3,200 mn

Incidence of tax on producer; ¥10 x 80 mn = ¥800 mn

Total incidence of tax. Govt. tax revenue; ¥50 x 60 mn = ¥3,000 mn

Incidence of tax on consumer; ¥20 x 60 mn = ¥1,200 mn

Incidence of tax on producer; ¥30 x 60 mn = ¥1,800 mn

Fig. 13.5 Expenditure tax on a) Cigarettes & b) Oranges

Both goods’ demand curves will have a marked effect upon whom the main incidence of tax will fall. The lower

the PED, the higher the increase in price due to the expenditure tax – and the more of the incidence of tax lands

upon the consumer.

Put in formula: (You’ll have to neaten up a bit in the formulae Rory.)

• Incidence of tax on the consumer =

∆ in P

T---------------

where P is the price to the consumer and T is the tax per unit

on the good. The proportional incidence of cigarette tax on the consumer is thus 40/50 which is 80%.

• Incidence of tax on the producer = 1-

∆ in P

T---------------

which is 1-0.8 or 20%

The unit tax on petrol (figure 13.5a) of ¥50 caused a far higher price hike than for oranges and put 80% of the

incidence of tax on the consumer. This makes intuitive sense, for as soon as consumers lack viable alternatives

they will be willing to pay a great deal of a price increase, something that firms are well aware of. Of the total

incidence of tax, consumers bear the burden of ¥40 x 80 million = ¥3,200 million while producers bear the

remaining ¥800 million.

Oranges (figure 13.5b) on the other hand have many possible substitutes – and hence a higher price elasticity of

demand – and this shows since consumers only bear 20% of the total tax burden. As for the question of which

good would be more suitable for taxation, I leave that to you to figure out.

• PES and the incidence of tax and government revenue We now look at the incidences of indirect taxation in relation to different supply curves. Let me be a trifle

provocative in the choice of goods with which to exemplify this. I will use nuclear energy as one good and coal as

the other. Let’s put in a few assumptions:

1. Nuclear power and coal are the only two available sources of electricity;

2. Both are perfect consumer substitutes with identical PED values;

3. Both industries are operating close to maximum output; and

4. Increasing nuclear power is far more supply inelastic than increasing coal powered electricity, as it takes a

great deal more time to install additional nuclear reactors than coal furnaces.

Once again, we assume that the original price and quantity are the same for both goods. Government now looks at

the possibility of levying a ‘green tax’ on one of the two alternatives. (I forego using actual figures now as you are

assumed to be on-line.)

• Figure 13.6a shows how an environment tax on nuclear power which has low price elasticity of supply

will put most of the tax burden on producers; the shift from S0 to S1 raises the price far less than the total

amount of tax. This puts the main incidence on producers, as shown by the orange rectangle.

• The alternative, coal-fired energy in figure 13.6b, has higher price elasticity of supply and puts the main

tax burden on consumers. The choice boils down, once again, to ‘who should pay the most’ and also

which of the two alternatives government wishes to dissuade use of. It is also clearly evident that quantity

demanded decreases more due to a tax when price elasticity of supply is high.

The final four examples show how PES and PED affect the incidence of tax such that it is 100% on either the

producer or consumer.

Q/t (gigawatts/month)

D

P ($/gigawatt)

P0

Q1 Q0

a) Nuclear power

S+tax S0

Tax

($/gigawatt)

Incidence of tax on producer

Incidence of tax on consumer

P1

P*

Q/t (gigawatts/month)

D

P ($/gigawatt)

P0

Q1 Q0

b) Coal power

S+tax

S0 P1

P*

Fig. 13.6a) & b) Effect of an expenditure tax on nuclear and coal power

P ($)

∆P = tax/unit; the incidence of tax is entirely on the consumer

S0

Q

Q/t

D

No ∆P due to tax; the incidence of tax is entirely on the producer

Perfectly inelastic demand (left diagram) will raise the price by the same amount of the tax (no change in Qd), as will perfectly elastic supply (right diagram). The entire incidence of tax thereby falls on the consumer.

Perfectly inelastic supply (left diagram) is trickier. Technically, the supply curve shifts up by the amount of the unit tax, i.e. stays in place. There is no change in quantity demanded – any tax will have to come out of producers’ pockets. A perfectly elastic demand curve (right diagram) means that demand is constant at a given price. Any movement along the demand means the price remains the same, so the entire

incidence of tax is levied on the producer.

Hint: Don’t try to commit the above to memory. I still haven’t! All one needs to do is remember that if a tax is levied and the price changes by the same amount as the tax, the consumer will bear the entire tax burden. In a case where the price doesn’t change,

then the producer will bear the entire incidence of tax.

Figure 13.7 Four extreme cases of the incidence of tax

Tax ($/unit)

P0

P1

S+tax P ($)

S0

Q0

Q/t

Tax ($/unit)

P0

P1

D

Q1

S+tax

P ($)

Q

Q/t

S

Tax ($/unit) P0

P ($) S0

Q/t

Tax ($/unit)

P0

D

Q1 Q0

S+tax

D

P*

P*

• Plotting linear supply and demand curves Here we will use the previous supply and demand functions from Chapters 4 – 6 to show and calculate the effects of an expenditure tax on goods. You will have to forgive me for including the “invisible elongated” portion of the Q-axis (i.e. the section showing minus values) for reasons of explanatory clarity. For the same reason, I have put a rather hefty tax on this particular good – since a $2 tax would be rather hard to see clearly in a diagram where the starting value is $100. So, with a equilibrium price and quantity of $100 and 2,000 units, we add a $50 tax:

• The supply function in Qs = -2,000 + 40P

• The new supply function needs to be calculated. A $50 tax raises the supply curve S0 by $50 at all quantity levels, thus we need to calculate the new value of ‘c’.

o The original P-intercept of the supply curve is 50 o The P-intercept of the supply curve is calculated by ‘c’ / ‘d’ o We know that the new P-intercept is 100 and that the slope (‘d’) is unchanged – thus we can

calculate ‘c’ by solving 100 = -c / 40; -c = 40 x 100 (Rory, I have NO IDEA how to handle the minus value of ‘c’. Jump in and save us.)

o The new value of ‘c’ is -4,000

• The new supply function is Qs = -4,000 + 40P

Now is a good time to refresh your memory by calculating the new equilibrium price and quantity. These values have been left blank in figure 13.9 for precisely that reason.

Figure 13.9 Unit tax on a good

0

150

200

1,000 2,000 3,000 4,000

Q/t (units/week)

P ($/unit)

S0

Qd = 4,000 - 20P

-2,000 -1,000

xx

xx

-3,000

Qs = -2,000 + 40P

D

S+tax Qs = -4,000 + 40P

-4,000

An alternative calculation: A 50 increase in ”run” (∆P) with a

slope of 40 must be a 50 fold decrease in ”rise” (∆Q). The original

value of ‘c’ is -2,000 plus 40 x -50 = -4,000. (Jump in here any

time Rory!)

-2,000

+ 50

Tax is $50 per unit

xx

100

50

New equilibrium quantity is given by solving the simultaneous equation -4000 + 40P = 4000 - 20P

• P; 8,000 = 60P, P = $133.33

• Qs; -4,000 + 40 x 133.33 = 1,333

o Incidence of tax There is an initial clue here that will help you check your figures! Any case where the slope of a (linear) supply curve is less than the slope of a (linear) demand curve, we know who will carry the largest incidence of tax; the consumer. Doodle a few diagrams to see why. (All ‘areas’ in the text below refer to figure 13.10.)

• Total incidence (areas 2 and 4); at a quantity of 1,333 and tax of $50, the total incidence (e.g. total government revenue is $66,666.

• Incidence of tax on consumers; the increase in price is $33.33. Consumers will pay $33.33 x 1,333 in tax which is $44,428.

• Suppliers will pay the remaining $22,217.

o Consumer and supplier surplus Go back and revise consumer surplus, supplier surplus and deadweight loss. That will make it easier for you to see the areas in figure 13.10 and follow the calculations. My wonderful classroom neighbour, Brett the Aussie Math Teacher and Ballroom Dancer, tells me that the easiest way to calculate remaining surplus is “…quantity times the relevant P-intercept minus everything else…then divide by two…” Or something like that.

• Remaining consumer surplus (area 1): ([$200 - $133.33] x 1333) / 2 = $44,435.5

• Remaining supplier surplus (area 6): ([83.33 – 50] x 1333) / 2 = $22,214.5

Figure 13.10 Consumer and supplier surplus, incidence of tax and deadweight loss

0

50

100

150

200

1,000 2,000 3,000 4,000

Q/t (units/week)

P ($/unit)

S0

5,000

133.33

83.33

D

S+tax

1,333

1

2 3

4 5

6

o Deadweight loss The deadweight loss is the sum of the net loss of consumer and supplier surplus. These are the two small triangles (areas 3 and 5 in figure 13.10) that are simply “lost” in levying a tax on a good. Looking at the $50 unit tax as the “base of a triangle”, we get ($50 x [2,000 – 1,333]) /2 = $16,675.

Simple worksheet

1. Assume a supply function of Qs = 200 + 10P and a demand function of Qd = 500 – 5P.

2. Draw a diagram showing initial equilibrium.

3. Add a unit expenditure tax of $10 and calculate the new supply function. Draw a new supply curve showing equilibrium price and quantity after the tax.

4. Calculate the total incidence of tax (government tax revenue).

5. Calculate the loss of consumer and supplier surplus.

6. Calculate the deadweight loss.

Summary and revision (need a cool pic here….maybe a pic of someone doing push-ups!)

1. Governments tax goods to either gain government tax revenue or decrease consumption of the good.

2. Expenditure taxes are indirect taxes. Consumers pay to firms which then pass on the tax to

government. This increases firm’s costs and thus decreases supply. 3. A specific tax – or unit tax – is an expenditure tax on goods based on a unit sold or consumed

such as €2 per bottle of wine or pack of cigarettes.

4. An ad valorem tax is a percentage added on to the base value or price of the good.

P ($)

S0

Q/t D

Tax ($/unit)

P0

P1

S+tax

HL extensions 5. The more price inelastic demand is the higher the incidence of tax is on the consumer

and the greater is the overall incidence of tax (government revenue).

P*

Q1 Q0

Specific tax (unit tax) Ad valorem tax

P ($)

S0

Q/t D

Tax (25%)

P0

125

S+tax

100

Q1 Q0

Govt revenue from tax

P ($)

S0

Q/t

D

Tax ($/unit)

P0

P1

S+tax

P*

Q1 Q0

Low PED

P ($)

S0

Q/t D

Tax ($/unit)

P0

P1

S+tax

P*

Q1 Q0

High PED

Incidence of tax on

producer

Incidence of tax on

consumer

Summary and revision…continued

HL extensions 6. Assume a supply function of Qs = -400 + 20 P. The P-intercept for the function is given by

‘c’ / ‘d’; 400/20 = $20. A unit tax of $5 will shift the supply curve upwards by the same amount – the P-intercept for the supply curve would go from $20 to $25.

7. To get the new supply function, we need to calculate the new value of ‘c’. This is given by

solving ‘c’ in the equation -c / 20 = 25. The new value of ‘c’ is -500. Another way to calculate ‘c’ is by shifting the supply curve to the left by the same proportion as the tax; the $5 tax is an increase of 25% so the supply curve will intercept the Q-axis at -400 x 1.25, i.e. -500.

8. Total incidence of tax is calculated by multiplying the unit tax by the new equilibrium

quantity. a. Incidence of tax on the consumer; (new equilibrium price minus original price)

times new equilibrium quantity b. Incidence of tax on the producer; total incidence minus the incidence on

consumers

9. Deadweight loss; ($5 x ([Q0 – Q1]) / 2