Question

There is a monopoly producer of smartphones facing the following demand Q = 400 - 2P (where Q is # of smartphones). Its cost is given by C = 100Q.  

(a) What are the equilibrium quantity and price of smartphones sold by the monopolist?

(b) If the government imposes an ad valorem tax of 20% on smartphones, what happens to the equilibrium quantity and price? What is the tax revenue collected? What is the tax incidence of this tax? (HINT: assume that the tax reduces MR not increases MC).

(c) If instead of the ad valorem tax of 20% the government wants to impose an equivalent excise (per unit) tax on smartphones, what tax amount should it use? What tax revenue would be collected? What would be the tax incidence? Why is the tax incidence on the monopolist higher in (b)? Please explain. (HINT: use the difference between the MR and price in your explanation).

d) If the government imposes an excise tax of $42 on smartphones instead, what happens to the equilibrium quantity and price and tax revenue? What is the tax incidence now? How does the tax incidence here compare to (c)? Please explain why this is the case. (e) If the ad valorem tax rate goes up above 20%, what would you expect to happen with the tax incidence and why? Please explain.

Answer 1