Question 2 (10 marks)

Suppose the government imposes an excise tax on a luxury good (i.e. for which there is elastic demand).

(a) Draw a supply-demand diagram to show the effects of this tax. The curves should reflect the case where demand is more elastic than supply. Label the initial equilibrium price and quantity: P0 and Q0, and the new equilibrium price and quantity: P1 and Q1.

(b) On your diagram, clearly show the amount of the tax paid for by

(i) the consumer, and

(ii) the producer