Sale and Purchase Taxes

# Sale and Purchase Taxes - Economics 21 Intermediate...

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Economics 21: Intermediate Microeconomics Topic 1: Introduction and Review - Sale and Purchase Taxes 1 Economics 21: Intermediate Microeconomics Topic 1: Introduction and Review Sale and Purchase Taxes Reference: Varian, Chapter 16 Outline: I. Introduction II. Linear Demand and Supply III. Per Unit (Quantity) Taxation IV. Comparison V. Optimal Taxation I. Introduction Describing a market before and after taxes the imposition of taxes is a useful exercise in comparative statics as well as being of considerable interest in the conduct of economic policy. II. Linear Demand and Supply Let demand in the market be represented by the equation: q d = a ! bp (1) The supply curve is simply a mapping of the profit maximising price-output pairs for each firm within the market. We can define it by the equation: q s = c + dp (2) Equilibrium in this market will occur at a price, * P , such that: q d p * ( ) = a ! bp * = c + dp * = q s p * ( ) (3) Implying: p * = a ! c b + d " # \$ % & (4) And: q * = ad + bc b + d ! " # \$ % & (5)

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Economics 21: Intermediate Microeconomics Topic 1: Introduction and Review - Sale and Purchase Taxes 2 III. Per-Unit (Quantity) Tax Recall that a quantity tax is a tax per-unit of the good either supplied or purchased. Assume first a per-unit sales tax: Per-Unit (Sales) Tax What happens if the government imposes a tax on production in this market? The answer lies in the supply curve. Recall that the supply curve shows the profit-maximising price-output pairs for the various firms in the industry. Since firms aim to maximise profits, it shows how much output sellers would supply to the market at each price. An alternative interpretation is that it shows the minimum (i.e. reservation) price sellers would accept for supplying a particular quantity of output to the market. Assume that the government imposes a tax of t per unit sold on sellers. The tax is paid over by to the government and so drives a wedge between the demand and supply price in the market. Without taxation the price paid by consumers is equal to that received by the seller.
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