Question

The figure above illustrates the market for antifreeze. Suppose the government decides to implement an $8 sales tax on the sellers for every gallon of antifreeze sold. 

a) What is the equilibrium price of a gallon of antifreeze before the tax? What is the price paid by buyers after the tax? 

b) What is the equilibrium quantity of antifreeze before the tax? What is the equilibrium quantity after the tax? 

c) What is the revenue collected by the government from this tax? 

d) Do buyers or sellers bear the largest incidence of the tax? 

e) Calculate the deadweight loss created by the tax.

Answer 1

a) The equilibrium price is $4. It is the price paid by buyer and received by sellers before the tax.

b) The equilibrium quantity is 8 thousand of gallons. The equilibrium quantity after the tax is is 4 thousand of gallons.

c) The revenue collected by the government is the shaded are in the diagram whose are is 4*6 = 24

d) Buyers bear the largest burden of tax as the price paid by buyers rises by $6 while the price received by seller fell by just $2 because the demand curve is more inelastic than the supply curve.

e) Deadweight loss is the area of triangle ABC which is 1/2 * 6 * 4 = 12