Question 1

Consider product Y with the following demand and supply functions:

Qd = 100 - 2p

Qs = -20 + 4p

The government has not currently imposed an indirect tax on product Y. However, the

production and consumption of product Y is considered undesirable. Subsequently, the

government imposes an indirect tax on the product. The consumer pays a price of $24 per

unit after tax. Assume the product has an income elasticity coefficient of +1.5.

Use the above information to undertake the following:

i.

Draw a demand and supply graph illustrating the market for Product Y both

before and after the imposition of the indirect tax.

ii.

Calculate the per unit tax.

iii.

Calculate and explain consumer surplus, producer surplus and deadweight loss

before and after the imposition of the indirect tax.

iv.

Calculate and interpret the own price elasticity of demand using the arc method.

v.

Calculate and explain the burden of the tax. Discuss the relationship between the

burden of the tax and the coefficient of elasticity calculated in part iv.

vi.

The government increases direct (income) tax by 8% and this decreases average

disposable income by 2%. Use the case study above as a guide to discuss the

impact of this policy on the demand for Product Y.

vii.

Explain whether the government is likely to increase indirect taxes or increase

direct taxes in order to discourage the consumption of Product Y.