Question

Q3.
a. Explain, with the aid of diagrams, the incidence of a unit sales tax.
b. Why might unit sales taxes be levied on alcohol and tobacco products?
c. What might be the expected result of a unit sales tax levied on all brands of apple juice?

Answer 1

a)

If a unit sales tax of $3 is imposed, it will increase the marginal cost by $3 and shift the supply curve to the left as per the above graph. The new price paid by the consumers will be 5, received by seller will be 2 and the quantity 2, compared to the perfect market outcome of price and quantity 4. The deadweight loss will be B+D. Tax borne by consumers will be A and tax borne by producers will be C.

Price Supply with Tax Supply 6.00 5.50 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 0 0.5 1.5 2 2.5 3 3.5 4 4.5 5 5.5 6 6.5 7 7.5 8 Quantity

b) Alcohol and tobacco products have a negative externality in terms of health effects that is not captured in the private marginal cost of the supplier, hence, unit sales tax might be imposed to internalize this cost.

c) The sales will be reduce for apple juice as the tax shifts the supply curve to the left as per the graph above.