Question

You are an assistant to a senator who chairs an ad hoc committee on reforming taxes on telecommunication services. Based on your research, AT&T has spent over $15 million on related paperwork and compliance costs. Moreover, depending on the locale, telecom taxes can amount to as much as 25 percent of a consumer’s phone bill. These high tax rates on telecom services have become quite controversial, due to the fact that the deregulation of the telecom industry has led to a highly competitive market. Your best estimates indicate that, based on current tax rates, the monthly market demand for telecommunication services is given by Q^d = 200 - 4P and the market supply (including taxes) is Q^S = 4P - 120 (both in millions), where P is the monthly price of the telecommunication services.

The senator is considering tax reform that would dramatically cut tax rates, leading to a supply function under the new tax policy of Q^S = 4.4P - 120. How much money per unit would a typical consumer save each month as a result of the proposed legislation?

Answer 1

In equilibrium before tax, Qd = Qs,

200 - 4P = 4P - 120

8P = 320

P = $40

In equilibrium after tax, Qd = Qs,

200 - 4P = 4.4P - 120

8.4P = 320

P = $38.10

Consumer saving per unit = $40 - $38.10 = $1.90