The paper “ Demand, Supply, and Taxes, Market Structure, Tax on Alcohol in Perfectly Competitive Market” is a fascinating variant of the assignment on macro & microeconomics. It is vital to note that under an unregulated market, equilibrium price and quantity are at the point of intersection between the supply curve and the demand curve as shown in figure 1 above. This equilibrium of an unregulated market is therefore a price of P* and quantity of Q*. When a tax of say t is imposed on the market for an alcoholic drink, the price will rise by P*+t = P1.
This represents the price to consumers. Before the imposition of a tax, both consumers and producers enjoy benefits derived from the equilibrium position. Initially, consumer surplus, which shows the differences between willingness to pay and the price, is the area under XOP*. On the other hand, the producer surplus is marked by the area under P*OY. This is profit given by revenue earned the minus the marginal cost of production. After the imposition of a tax, t, price to consumers changes to P1.
Consequently, consumer surplus falls by area P1MOP*. On the producer side, tax leads to a fall in producer price to P2. In this case, the producer surplus is slashed by the area under points P*P2OZ. By imposing tax, t, the government obtains revenue of Qt*t. This government revenue is area P1P2MZ. Taxes further has a consequence of bringing about losses to the consumer and producer i. e. area MOX. This part is not collected by the government and is hence a deadweight loss. The slope of demand and supply curve and its effect on taxesThe slope, otherwise termed as elasticity, shows the degree of responsiveness.
This concept of slope determines the burden of taxes. To understand tax incidence, it is vital for a person to note that taxes are based on transactions and not persons. In this case, a tax of $1 on alcoholic drink means that there should be a difference of $1 between what a consumer pays and what a seller gets. The distribution of this tax depends on elasticity or rather the slope of demand and supply curve. In a situation of a very inelastic demand curve, (i. e.
consumers are unresponsive to changes in prices) and very elastic supply curve, (i. e. producers respond fast to changes in price) the consumers bear more bulk of tax burden while producers bear less. This concept is also analyzed by looking at consumer and producer surplus. A scenario where both demand and supply curve has the same elasticity, consumer and producer surplus is reduced by the same ratio of tax. Conversely, if demand is inelastic while supply is elastic, consumer surplus is reduced by greater value when a tax is imposed as compared to producer surplus. The graph in figure 2 below is an inelastic demand and shows how more tax falls on the consumer. Figure 2: Inelastic demand In figure 2 above, consumer surplus is reduced more by tax t, when compared with producer surplus.
Owing to the fact that demand for alcohol is elastic, taxes motivate producers to change their behavior since the burden to pay tax fall on them. The primary purpose of proposed alcohol taxationGordon (Np) alludes to changes in alcohol taxation as proposed by Treasury boss Ken Henry.
This change to the “ volumetric system” would have the effect of the increasing price of full-strength beer. It is quite clear that the primary purpose of the proposed system is to reduce health and social cost following the abuse of alcohol. This is true given that volumetric taxes would raise the price of different categories of alcohol by close to 5%. The upward price trend is also expected in wines. Apart from reducing alcohol consumption, Gordon notes that the new system will boost revenue by $2.9 billion.
The bottom line of volumetric tax is cultivating responsible consumption of alcohol with a view of curbing accidents and injuries. A rationalized and excise tax regime was recommended by a task force on preventive health. PART 2: Market Structure A graph for a perfect competitive alcohol market A perfectly competitive market has many firms supplying the same product. In such a situation, firms are price takers since they have minimum control over market prices. The intersection of demand and supply curve in a perfectly competitive market indicates the price level.
Buyers and sellers must accept this price whilst a firm, which tries to increase its price beyond the market price, will not attract buyers. This is because the consumer will resort to other firms that sell the same good at a lower price. Figure 3: A firm in a perfectly competitive market. The graph above illustrates a firm in a perfectly competitive market. The price of alcohol in a firm is equal to its marginal revenue and average revenue i. e. P=MR=AR. This price level also signifies the demand curve of a firm and further shows the price at which buyers are willing to pay for any quantity of alcohol.
In summary, firms in a perfectly competitive market can sell any quantity of alcohol at the same price and that is why D=P=MR. Figure 4: Imposing tax in a perfectly competitive market When tax is introduced in the market, price changes to P2 from P1. The tax on alcohol becomes t as illustrated in figure 4. This tax is shared between the consumer and producer in the competitive market within a short-run period. Figure 5 below illustrates the effect of taxes on a consumer given a competitive market situation and over a long-run period.
The Marginal Revenue will shift upward from MR1 to MR 2 as shown below. The tax burden falls more on the consumer given by the reduced consumer surplus. Figure 5: Effect of tax on a firm on a long-run basis given a perfect competition. Taxes in a monopoly market A monopoly is a situation with a single supplier in the market. The demand curve is downward sloping and has the ability to set its own price. Figure 6: Monopoly A monopolist will set the price where MR=MC.
If a tax on alcohol is introduced, marginal cost will shift upward from MC1 to MC2 as shown above. The effect of tax on monopoly is to reduce consumer and producer surplus while increasing deadweight loss. Reduction in producer surplus is mainly attributed to taxes paid.
Works CitedGordon, Josh. “Tax shake-up to hit beer, wine prices.” The Age Web, 17 January, 2010. Retrieved from: www.theage.com.au.