The demand for good Q is given by Q d = 10 – P. The supply of good Q is perfectl

Question

The demand for good Q is given by Qd = 10 – P. The supply of good Q is perfectly elastic. The firms in the industry are willing to produce and sell any number of units of good Q, as long as they receive a price of $5. Thus the supply curve can be expressed as P = 5. Now the government imposes a tax of $2 on each unit of good Q. Thus the gross-of-tax supply curve is given by P = 7.  

1.The equilibrium quantity before the tax is imposed is __________, and the equilibrium quantity after the tax is imposed is _________.

2.How much tax revenue is raised by the tax?

3.What is the excess burden (or deadweight loss) of the tax?

Explanation / Answer

Equilibrium quantity before price rise is Q=5, (substitute p=5 in the demand equation).

It would now be equal to Q=3 (substitute p=7 in the demand equation).

Tax revenue will be 3*2 = 6.

Deadweight loss = 2*1/2*b*h. b is the decreased demand and h is the increased price.

= 2*0.5*2*2

=4. It can also be derived by calculating 5*5 - 3*7 = 4.

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