Question

Suppose that the government of China decided to impose a per unit tax on the suppliers of salt.
(a) Using a supply and demand model, show and explain the impact that the per unit tax had on the equilibrium price and quantity of salt. (4 marks)
(b) Using the diagram created for your answer to (a), show and explain what effect the per unit tax had on consumer surplus, producer surplus and deadweight loss. (6 marks)   
(c) List three reasons a government may impose a tax. Discuss the link between government revenue from taxation and elasticity of demand. (5 marks)

Answer 1

Ans) When government imposes tax, burden is shared by both buyers and sellers. But who will bear more burden of the tax, depends upon the elasticity of demand and supply. Consequently, the less elastic side of the market bears greater burden of the tax.

Tax reduces both consumer and producer surplus. It raises the price paid by buyers and reduces the price received by sellers. It reduces the quantity sold and raises revenue for the government. It also creates deadweightloss which means loss in market efficiency.

When demand is less elastic, tax burden falls more upon the buyers and when demand is more elastic, tax burden falls more upon the sellers. Further, when demand is more elastic, government revenue is less and deadweightloss is more. And if demand is less elastic government can raise more tax revenue with less deadweightloss.

Reasons government impose tax÷

• To raise money for day to day business.
• Firm is producing negative externality i.e polluting environment.
• Government imposes tax to discourage some activities like consumption of alcohol.

Before tax , Consumer surplus Producer surplus de

After tax consumer surplus government revenue D deadweightloss producer surplus 8 9

price received by sellers - price paid by buyers producer burden consumer burden deadweightloss SITAT

consumer burden (less) - deadweightloss buyers īAX price paid by price received by sellers Demand more elastic producer burden (more)