Demand, Supply, and Taxes, Market Structure, Tax on Alcohol in Perfectly Competitive Market - Assignment Example

Running Head: Economics for Managers Your name Course name Professors’ name DatePART 1: Demand, Supply, and Taxes 1. Tax effect on an initially unregulated market Figure1. Unregulated market and tax effects It is vital to note that under unregulated market, equilibrium price and quantity is at the point of intersection between the supply curve and the demand curve as shown in figure 1 above. This equilibrium of unregulated market is therefore a price of P* and quantity of Q*. When a tax of say t is imposed on the market for alcoholic drink, the price will rise by P*+t = P1. This represents the price to consumers. Before imposition of a tax, both consumers and producers enjoy benefits derived from equilibrium position. Initially, consumer surplus, which shows the differences between willingness to pay and the price, is the area under XOP*. On the other hand, producer surplus is marked by area under P*OY. This is profit given by revenue earned minus marginal cost of production. After imposition of tax, t, price to consumers changes to P1. Consequently, consumer surplus falls by area P1MOP*. On the producer side, tax leads to a fall in producer price to P2. In this case, producer surplus is slashed by area under points P*P2OZ. By imposing tax, t, the government obtains revenue of Qt*t. This government revenue is area P1P2MZ. Taxes further has a consequence of bring about losses to the consumer and producer i.e. area MOX. This part is not collected by government and is hence a deadweight loss. 2. Slope of demand and supply curve and its effect on taxes The slope, otherwise termed as elasticity, shows the degree of responsiveness. This concept of slope determines the burden of taxes. To understand tax incidence, it is vital for a person to note that taxes are based on transactions and not persons. In this case, a tax of $1 on alcoholic drink means that there should be a difference of $1 between what a consumer pays and what a seller gets. The distribution of this tax depends on elasticity or rather the slope of demand and supply curve. In a situation of very inelastic demand curve, (i.e. consumers are unresponsive to changes in prices) and very elastic supply curve, (i.e. producers respond fast to changes in price) the consumers bear more bulk of tax burden while producers bear less. This concept is also analysed by looking at consumer and producer surplus. A scenario where both demand and supply curve have same elasticity, consumer and producer surplus is reduced by the same ratio of tax. Conversely, if demand is inelastic while supply is elastic, consumer surplus is reduced by greater value when a tax is imposed as compared to producer surplus. The graph in figure 2 below is an inelastic demand and shows how more tax falls on the consumer. Figure 2: Inelastic demand In figure 2 above, consumer surplus is reduced more by tax t, when compared with producer surplus. Owing to the facts that demand for alcohol is elastic, taxes motivate producers to change their behaviour since burden to pay tax fall on them. 3. Primary purpose of proposed alcohol taxation Gordon (Np) alludes to changes in alcohol taxation as proposed by Treasury boss Ken Henry. This change to “volumetric system” would have the effect of increasing price of full- strength beer. It is quite clear that the primary purpose of the proposed system is to reduce health and social cost following abuse of alcohol. This is true given that volumetric taxes would raise price of different categories of alcohol by close to 5%. Upward price trend is also expected on wines. Apart from reducing alcohol consumption, Gordon notes that the new system will boost revenue by $2.9 billion. The bottom line of volumetric tax is cultivating responsible consumption of alcohol with a view of curbing accidents and injuries. Rationalised and excise tax regime was recommended by a taskforce on preventive health. PART 2: Market Structure 1. A graph for a perfect competitive alcohol market A perfect competitive market has many firms supplying the same product. In such situation, firms are price takers since they have minimum control over market price. The intersection of demand and supply curve in a perfectly competitive market indicates the price level. Buyers and sellers must accept this price whilst a firm, which tries to increase its price beyond the market price, will not attract buyers. This is because consumer will resort to other firms that sell the same good at lower price. Figure 3: A firm in a perfectly competitive Market. The graph above illustrates a firm in a perfectly competitive market. The price of alcohol in a firm is equal to its marginal revenue and average revenue i.e. P=MR=AR. This price level also signifies the demand curve of a firm and further shows the price at which buyers are willing to pay for any quantity of alcohol. In summary, firms in a perfectly competitive market can sell any quantity of alcohol at the same price and that is why D=P=MR. 2. Tax on alcohol in perfectly competitive market Figure 4: Imposing tax in a perfectly competitive market When tax is introduced in the market, price changes to P2 form P1. Tax on alcohol becomes t as illustrated in the figure 4. This tax is shared between the consumer and producer in the competitive market within a short run period. Figure 5 below illustrates the effect of taxes on a consumer given a competitive market situation and over a long run period. The Marginal Revenue will shift upward from MR1 to MR 2 as shown below. Tax burden falls more on the consumer given by the reduced consumer surplus. Figure 5: Effect of tax on a firm in long run basis given a perfect competition. 3. Taxes in a monopoly market A monopoly is a situation with a single supplier in the market. The demand curve is downward sloping and has the ability to set own price. Figure 6: Monopoly A monopolist will set the price where MR=MC. If a tax on alcohol is introduced, marginal cost will shift upward from MC1 to MC2 as shown above. The effect of tax on monopoly is to reduce consumer and producer surplus while increasing deadweight loss. Reduction in producer surplus is mainly attributed to taxes paid. Works Cited Gordon, Josh. “Tax shake-up to hit beer, wine prices.” The Age Web, 17 January, 2010. Retrieved from: www.theage.com.au. Read More