Question

Suppose that the market for fine champagne is currently in equilibrium. The demand and supply functions are as follows:

QS = (1⁄2) P
QD= 12 – (1/4)P

a. Calculate the equilibrium quantity and price. Then graph supply and demand and show the equilibrium.

b. Suppose that the government is considering a tax of $12 per bottle of champagne. Calculate each of the following:

i. The change in equilibrium quantity due to the tax.
ii. The change in the price buyers pay (PB) due to the tax.
iii. The change in the net price sellers receive (PS) due to the tax.
iv. The change in consumer surplus due to the tax.
v. The change in producer surplus due to the tax.
vi. The Government revenue from the tax (assume that it was zero before the tax).

c. Show in your graph the changes due to the tax. Use different colors to shade the areas corresponding to the new (after-tax) consumer surplus, producer surplus, and government revenue from the tax.
d. Suppose that one goal of the government is for the tax to reduce the consumption of champagne. What would the demand function for champagne have to look like for the tax to be completely ineffective at reducing champagne consumption? Sketch the new function in your graph and explain clearly the economics.

Answer 1