Under perfect competition, we found that the economic incidence of a tax—i.e. who ends up paying a tax—had nothing to do with statutory incidence—i.e. who the law said should pay the tax.
A: Suppose the government wants to tax the good x which is exclusively produced by a monopoly with upward sloping marginal cost.
(a) Begin by drawing the demand, marginal revenue and marginal cost curves. On your graph, indicate the profit maximizing supply point (xM,pM) chosen by the monopolist in the absence of any taxes.
(b) Suppose the government imposes a per-unit tax of t on the production of x — thus raising the marginal cost by t . Illustrate how this changes the profit maximizing supply point for the monopolist.
(c) What happens to the price paid by consumers? What happens to the price that monopolists get to keep (given that they have to pay the tax)?
(d) Draw a new graph as in (a). Now suppose that the government instead imposes a per-unit tax t on consumption. Which curves in your graph are affected by this?
(e) In your graph, illustrate the new marginal revenue curve—and the impact of the consumption tax for the monopolist’s profit maximizing output level.
(f) What happens to the price paid by consumers? What happens to the price that monopolists get to keep (given that they have to pay the tax)?
(g) In terms of who pays the tax, does it matter which way the government imposes the per-unit tax on x?
(h) By how much does deadweight loss increase as a result of the tax? (Assume that demand is equal to marginal willingness to pay.)
(i) Why can’t monopolists just use their market power to pass the entire tax onto the consumers?
B: Suppose the monopoly has marginal costs MC = x and faces the demand curve p = 90−x as in exercise 23.1.
(a) If you have not already done so, calculate the profit maximizing supply point (xM,pM) in the absence of a tax.
(b) Suppose the government introduces the tax described in A(b). What is the new profit maximizing output level? How much will monopolists charge?
(c) Suppose the government instead imposed the tax described in A(d). Set up the monopolist’s profit maximization problem and solve it.
(d) Compare your answers to (b) and (c). Is the economic incidence of the tax affected by the statutory incidence?
(e) What fraction of the tax do monopolists pass onto consumers when monopolists are statutorily taxed? What fraction of the tax do consumers pass onto monopolists when consumers are statutorily taxed?