Answer to Question #180416 in Microeconomics for Darshana

Question

(a) Illustrate with the help of a diagram, higher the price elasticity of supply, larger will be the per unit tax burden borne by the consumers. 5 (b) The demand and supply functions of a good are given by QD = 24 − 3P; QS = 4 + 2P where P, QD and QS denote price, quantity demanded and quantity supplied, respectively. Find the inverse demand and supply functions and the market equilibrium price and quantity. 

Answer 1

Solution:

a.). Tax incidence is the way in which the tax burden is allocated between buyers and sellers. When the price elasticity is larger, buyers will tend to bear most of the tax burden.

This is illustrated by the below graph:

 

 

 

 

 

 

b.). Inverse demand function:

QD = 24 – 3P

3P = 24 – QD

P = 8 – 1/3QD

Inverse Supply function:

QS = 4 + 2P

2P = 4 – QS

P = 2 – 0.5QS

 

Market equilibrium price and quantity:

At equilibrium: QD = QS

24 – 3P = 4 + 2P

24 – 4 = 2P + 3P

20 = 5P

P = 4

Substitute for Q:

QD = 24 – 3P

QD = 24 – 3(4)

QD = 24 – 12

QD = 12

Market equilibrium price = 4

Market equilibrium quantity = 12