Question

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1. Suppose that the local legislative body in Your College Town (YCT) decides to levy a tax of $.50 for each 12 ounces of beer sold in the city (both by the drink and packages). The city sees the tax as a way to have students pay more for the city services they receive. Suppose that the beer market in YCT is competitive, the long-run industry supply in YCT is perfectly elastic, and the demand for beer in YCT is very price elastic.  
   1. Graph the market for beer in YCT, with the initial equilibrium quantity and price, and the effect of the new tax
   2. What will the effects of the tax be on the price of beer in YCT, the amount of beer sold, and the number of beer stores and bars in YCT?
   3. Why might the demand for beer in YCT be so price elastic, given that it is known that overall demand for beer is rather inelastic? In view of that, what do you expect the effect of the tax will be on beer sales and the number of stores and bars in surrounding cities?

Answer 1

a) The following graph shows the initial equilibrium at e and the new one at e1 with respective quantity.

Beer mu

b) The amount of beer sold will also decrease. With the decrease in supply there will also be decrease in demand. The increase in tax has resulted the price to be higher, hence this would discourage the demand which would therefore lead to closing of beer shops and bars in the area.

c) Beer is not a necessity. In general those goods that are extremely imnportant are inelastic like salt and medicines. However, beer can be susbtituted with other alcoholic drinks. It can have reduced demand pertaining to the fact that only those who could afford it despite the higher tax levied will be buying it. The beer sale will come down due to the decreases demand in the YCT. However, when other areas are concerned, they might see higher sale numbers due to ;lesser price they offer.