Question

The following graph represents the market for Red Sox baseball caps. A Yankees fan has been elected governor and has instituted a $5 tax on every Red Sox cap sold. In an attempt to hide the tax from voting Red Sox fans the governor makes the sellers pay the tax 11. 35 25 20 15 0 a. a) Shift the appropriate curve to show the effect of this tax. b) Label the new equilibrium quantity as Q c) Who bears the greater burden of this tax, buyers or sellers? d) How would your answer to part c change if buyers had to pay the tax instead of sellers?

Answer 1

In the diagram below, the initial equilibrium is at E .Given that the tax is levied on the seller, the supply curve will shift upward or to the left and new equlibrium is reached at E' where the quantity traded has decreased and the price for the cap has increased.

C.)Even though the incidence of tax depends upon the elasticity of supply and demand, i.e the one with the more inelastic curve will have to borne a higher burden of the tax.but since we are given that the seller had to pay the per unit tax of $5, so we assume that the whole tax burden is borne by the seller.

D.) If the buyer had to pay the tax instead of the seller, then we would shift the demand curve down to the left.The new price that the buyer had to pay is P^d  .