Suppose the government institutes a new sales tax on shoes, which are produced b

Question

Suppose the government institutes a new sales tax on shoes, which are produced by a competitive constant-cost industry.
a. Does the price of shoes change by more in the short run or in the long run?

b. Does the industry-wide quantity change by more in the short run or in the long
run?
c. Does the quantity provided by each shoemaker change by more in the short run
or in the long run?

d. Do the profits of shoemakers change by more in the short run or in the long run?

Explain.

The only one I got was

c) long run, they can expand their operations, such as buying more machines. Long run supply curve is more leastic than the short run supply curve.

d) long run, it takes time for the shoemakers to add new machines, the cost of the machine is fixed in the short run but variable in the long run.

I'm not sure if they are right though.

Explanation / Answer

a.) short run. In the long run the increase in taxes will be offset by companies finding a way to reduce the cost of production, although the (this model assumes no inflation but that is a normal assumption for a simple model like this.) b.) short run. in the long run some companies will go out of business and others will adjust. companies will adjust by selling the shoes by reducing cost of production d.) You're right about the adjustment, but your analysis is a bit off. In the short run because the companies can only offset the decrease in profit from the tax increase by laying off workers they will experience a larger loss in profit than in the long run. Remember the question asked when profits CHANGE more, not when they will increase. Over time the reduced profit from the tax increase will be offset by improvements in manufacturing, in the short run there's not much that can be done to offset them.

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