Question

Difficulty: Very hardIncidence and Effects of Taxation

The market demand and supply functions for a commodity are given as Qd=120−2PQ_d = 120 - 2P and Qs=20+3PQ_s = 20 + 3P respectively, where PP is the price in Naira (₦\text{₦}) and QQ is the quantity in units. If the government levies a specific sales tax of ₦10\text{₦}10 per unit on the producers, what is the per-unit tax burden borne by the consumer?

Answer: 6 ₦

Answer

The per-unit tax burden borne by the consumer is \text{₦}6.
The initial market clearing price is found by setting 120−2P=20+3P120 - 2P = 20 + 3P, which gives P1=₦20P_1 = \text{₦}20. With a specific tax of ₦10\text{₦}10 per unit levied on producers, the price received by sellers becomes Ps=Pc−10P_s = P_c - 10. Substituting into the supply equation gives Qs′=20+3(Pc−10)=3Pc−10Q_s' = 20 + 3(P_c - 10) = 3P_c - 10. Equating demand and post-tax supply gives 120−2Pc=3Pc−10  ⟹  5Pc=130  ⟹  Pc=₦26120 - 2P_c = 3P_c - 10 \implies 5P_c = 130 \implies P_c = \text{₦}26. The consumer tax burden per unit is the price increase, 26−20=₦626 - 20 = \text{₦}6.

Step-by-Step Solution

1
Calculate the pre-tax equilibrium price
Initial price P1=₦20P_1 = \text{₦}20
Equating quantity demanded Qd=120−2PQ_d = 120 - 2P and quantity supplied Qs=20+3PQ_s = 20 + 3P gives 120−2P=20+3P120 - 2P = 20 + 3P, which solves to P1=20P_1 = 20.
2
Adjust the supply equation to account for the specific tax of \text{₦}10 per unit
New supply function Qs′=3Pc−10Q_s' = 3P_c - 10
Because the tax is paid by producers, the net price received by sellers is Ps=Pc−10P_s = P_c - 10. Substituting PsP_s into Qs=20+3PsQ_s = 20 + 3P_s yields Qs′=20+3(Pc−10)=3Pc−10Q_s' = 20 + 3(P_c - 10) = 3P_c - 10.
3
Calculate the post-tax equilibrium price paid by consumers (PcP_c)
Post-tax consumer price Pc=₦26P_c = \text{₦}26
Equating QdQ_d and Qs′Q_s' gives 120−2Pc=3Pc−10120 - 2P_c = 3P_c - 10, which simplifies to 5Pc=130  ⟹  Pc=265P_c = 130 \implies P_c = 26.
4
Calculate the consumer's share of the per-unit tax incidence
Consumer tax incidence = \text{₦}6
The per-unit tax incidence on the consumer equals the net increase in market price paid, Pc−P1=26−20=6P_c - P_1 = 26 - 20 = 6.

Key Concept

Tax Incidence and Price Elasticity of Demand and Supply
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