Tax effect on price and quantity relationship

Impact of an Excise Tax or Subsidy on Price

tax effect on price and quantity relationship

If the tax is imposed on car buyers, the demand curve shifts down by the . The equilibrium price of Frisbees is $8 and the equilibrium quantity is 6 million Frisbees. b. If there's a price ceiling of $9, it has no effect, since the market equilibrium price is $8, below the ceiling. Figure 9 shows a graph of this relationship. Tax. Explaining with diagrams how the elasticity of demand determines the impact of a tax - on price, revenue and quantity. Inelastic demand - only. Taxes do not greatly affect the equilibrium quantity. You can see the relationship between tax incidence and elasticity of demand and supply represented.

The demand and supply functions can be represented as curves in a graph, such as is shown below. Let peq and qeq the price and quantity where the demand and supply curves intersect. Let D p be the demand function for the market and S p the supply function. At peq the quantity demanded is exactly equal to the quantity supplied and there is no tendency for the price to change.

It is, in fact, the equilibrium price.

tax effect on price and quantity relationship

The quantity demanded and supplied at that price is the equilibrium output, qeq. The Impact of an Excise Tax Suppose a tax of t is imposed upon the commodity and the tax is collected from the producers. In this case the producers would still be gettiing peq and thus would supply the same amount qeq. This shortage would drive the price down. In the above graph Pt represents the price paid by consumers once the tax is imposed.

Pt' is the price received by the producers once the tax is imposed. The difference between Pt and Pt is equal to the amount of the tax. The effect of the tax is to shift the supply curve, which is S without the tax, to St.

The shift is an upward shift by the amount of the tax, but the upward shift is the same as a backward shift, a decrease in supply.

tax effect on price and quantity relationship

As can be seen from the above graph, the impact of the tax is an increase in the price paid by consumers and a decrease in the price received by producers. Thus the consumers and producers share the burden of the tax. In this case the burden of the tax is equally shared by the consumers and producers, but that has to do with the relative slopes of the demand and supply curves.

From this graph the loss in consumers' surplus and the loss in producers' surplus may be determined as shown below. The loss in consumers' surplus is shown in pink and the loss in producers' surplus in light blue cyan.

The combined loss in consumers' and producers' surplus is offset in part by the gain to the government in tax revenue. But the offset is only partial; the loss to consumers and producers is greater than the tax revenue gained, as is shown below. The Impact of a Subsidy Although the analysis of the impact of a tax is important the analysis of the impact of a subsidy is more interesting. The analysis is essentially the same, a subsidy merely being a negative tax.

The effect of a subsidy is to shift the supply curve downward by the amount of the subsidy. Effectively this is an increase in supply. Here, the rents are reversed in sign, but the principle stays the same.

tax effect on price and quantity relationship

In general, the extent to which the equlibrium quantity traded is affected is negatively related to the price-elasticities of both demand and supply. In other words, if we reduce the price-elasticity of either demand or supply, the sensitivity of the equilibrium quantity traded to the sales tax reduces.

In particular, if either demand or supply is perfectly price-inelastic, the equilibrium quantity traded is independent of the sales tax. Effect of sales tax on a single good with a monopolist-controlled market We consider comparative statics between two situations: A world where there are no sales taxes A world where sales taxes are introduced on a single good or class of goods that is supplied by a single seller the monopolist that seeks to maximizing profit.

Effect of sales tax on market price and quantity traded - Market

The marginal revenue from the sale of a good equalsas is revenue and we are interested in the rate of change of revenue as quantity changes. Using the product rule for differentiationwe find that.

How to calculate Excise Tax and determine Who Bears the Burden of the Tax

As such, marginal revenue is less than the price paid, and it may even be zero or negative. Unlike the perfectly competitive market case discussed previously, we do not perform two separate analyses pre-tax and post-tax. Rather, we consider various pre-tax and post-tax curves together.

The reason is that a "post-tax supply curve" does not make sense in the monopoly case. Also, the analysis is complicated enough as it is, so creating two versions of it isn't worth it! Key curves under consideration We want to perform comparative statics between the world without sales tax and the world with sales tax.

We consider the marginal cost, demand, and marginal revenue curves for the latter in terms of the pre-tax prices. Pre-tax marginal cost curve: The marginal cost curve using pre-tax prices is expected to remain the same as the marginal cost curve in a world without taxes, because the price that the seller sees is the pre-tax price.

The pre-tax demand curve changes relative to what it is in a world without taxes. In general, it moves downward. Assuming the law of demand, that is the same as moving inward, i. Arithmetically, the new demand curve is related to the old demand curve either through proportional shrinkage toward the quantity axis for a revenue-proportional sales tax or through a downward translation toward the quantity by the amount of the tax on unit quantity.

For more, see the analysis of pre-tax prices section for the perfectly competitive case. Pre-tax marginal revenue curve: The pre-tax marginal revenue curve changes relative to what it is in a world without taxes. Qualitatively, the way it changes is the same as the way the demand curve changes.

Effect of tax – depending on elasticity

Micro-Level On the micro-level, an imposition of taxes involves charging duty on, for instance, gasoline or sales of other items. It has been mentioned that the supply curve intersects the y-axis.

  • Effect of taxes and subsidies on price
  • The Imposition of Taxes and Supply & Demand
  • Effect of sales tax on market price and quantity traded

This addition of prices has the effect of shifting the supply curve upward by the amount of tax charged. The supply curve then intersects the demand curve at a new location.

This creates a new level of quantity supplied, at a level less than the equilibrium amount, and a new price, at more than the equilibrium amount.

tax effect on price and quantity relationship

The new equilibrium price level minus the old price level is equal to the amount of tax paid by the consumer. The exact increase depends on the slope of the demand curve. Macro-Level On the macro-level, the imposition of taxes may involve an increase in income tax.