I have an answer for this but I just would like to know if I\'m on the right tra

Question

I have an answer for this but I just would like to know if I'm on the right track...

For five years, an oil drilling company has operated profitably in the state of Alaska (the only place it operates). Last year, the state legislature instituted a flat annual tax of $100,000 on any company extracting oil (or natural gas) in Alaska. How would this tax affect the amount of oil the company extracts? Explain. Suppose instead the state imposes a wellhead tax—that is, oil companies must pay a tax of $2.00 on each barrel of oil extracted. How would this tax affect the amount of oil the company extracts? Explain.

Explanation / Answer

Govt has imposed the flat tax on firm. Hence this is fixed cost for firm. Firm will keep producing optimal production as long as it is able to earn the profit. Fixed cost in the form of tax will have no bearning on output decision.

Imposition of tax $2.0 per barrel will effect the output decision of firm. It will shift the MC upwards, hence new equilibrium MR=MC will produce lesser output.

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