Question

Please explain the following in your own words:

1. Characteristics of Perfect Competition with an example

2. Difference between inelastic and elastic demand with examples

3. Effect of tax imposition on buyers and sellers

4. Consumer surplus and producer surplus with examples

5. Relationship between the tax size and tax revenue and tax size and deadweight loss

Each response must be four full lines.

Answer 1

1. Perfect competition is a market where large number of buyers and sellers are dealing in homogenous products.

Features.

1. Large number of buyers and sellers.

2. Homogenous products.

3. Perfect knowledge about the market.

4. Freedom of entry and exit.

Example: The perfect competition is theoretical concepts. Its best example is difficult to find out. Even though the agricultural market is the nearest example of perfect competition.

2. Difference between elastic and inelastic demand.

Elastic demand	Inelastic demand
1. The proportionate change in demand is more than the proportionate change in price	The proportionate change in demand is less than the proportionate change in price.
2. The elasticity quotient is greater than 1	The elasticity quotient is less than 1
3. The demand curve is less steep.	The demand curve is more steep.
4. The total revenue moves opposite to the price.	Revenue and price move in the same direction.

Example: The demand for luxury goods like Flat screen T.V and Luxury cars having elastic and demand for necessaries like wheat and rice are inelastic.

3. Tax on consumers reduce the consumption and reduce the consumer satisfaction. For example a sale tax is borne by the end consumer. Thus the tax reduces his surplus he gains from the market. A tax on sellers or manufactures increases the cost and reduces the supply. For example the imposition of excise duty falls on the producers and reduces the seller’s profit. Thus a tax on sellers reduces the producer’s surplus.

4. Consumer surplus is the extra satisfaction that the consumers enjoy while purchasing a commodity. It is the difference between the price that a consumer is willing to pay and the price he actually paid. Producer’s surplus is the extra satisfaction that the sellers obtain from the sale of a commodity. It is the difference between the price that a producer is willing to sell and the price he actually received.

For example if a consumer is willing to pay $4 for a commodity. If he get the product at a price of $2. The consumer surplus is $2.

If a producer is willing to sell a product at $10, but he receives a price of $15 from the market, the consumer surplus is $5.

5. The tax size and tax revenue are related inversely. More the tax size less will be the revenue from tax collection since the worker incentive to work decrease as he wants to pay higher amount of tax by earning higher income. A higher commodity tax reduces the demand of the product and hence the revenue collected from tax decrease (if demand is elastic). A higher tax on corporate entities reduces the volume net profit from business and reduces net investment and source of revenue.

The deadweight loss of taxation is the adverse effect of a tax on the economic efficiency. A tax on commodity reduces its demand (if demand is elastic). This fall in demand reduce the total production in the economy. Thus the producer surplus and consumer’s surplus decrease. This cause deadweight loss to the entire society. On the other hand a tax on the supply reduces the quantity of supply (if supply is elastic) and price increase. This cause loss of satisfaction to the producers and consumers.