Answer to Question #174733 in Microeconomics for Tamanna

Question

Suppose government imposes $2 tax on each liter of petrol purchased and all petrol vehicle users require paying the same.

i. Draw a demand and supply diagram of the market for petrol without the tax. Show the price paid by consumers, price received by producers and the quantity of petrol sold. What is the difference between price paid by consumers and received by producers?

ii. Draw a demand and supply diagram of the market for the petrol with the tax. Show the price paid by consumers and received by producers and the quantity of petrol sold. What is the difference between the price paid by consumers and received by producers? Has the quantity of petrol sold increased or decreased? (6, 6)

b. What is the Deadweight loss of taxation? How does the deadweight loss change with the change in size of the tax? Give reasons.

Answer 1

(I)

Consumers will pay p^*

Buyers will receive p^*

Quantity of petrol produced will be Q^*

There is no difference of price paid by consumers and price received by producers. At equilibrium the price paid by consumers will be the same as the price producers receive which is p^*as shown in the graph.

(ii)

consumer will pay PB .

PB=ps+2

Producers will receive ps

Quantity of petrol produced will be Q2

The difference of price paid by consumers and price received by producers will be the tax.

=Price of buyers- price producers receive

=Ps+2-ps=2

The quantity of petrol sold will reduce from Q1 to Q2

(b) dead weight loss of taxation will be the area between C and E. The dead weight loss increases as the tax increases . Tax revenue depends on tax levied. An increase in tax increase tax revenue which increases the burden of production.