A sales tax of 10% is placed on half the firms (the polluters) in a competitive industry. The revenue is paid to the remaining firms (the non polluters) as a 10% subsidy on the value of output sold.
a) Assuming that all firms have identical constant long-run average costs before the sales tax-subsidy policy, what do you expect to happen (in both the short run and the long run) to the price of the product, the output of firms, and industry output?
b) Can such a policy always be achieved with a balanced budget in which tax revenues are equal to subsidy payments? Why or why not? Explain.