Suppose the demand function for a product is P = 100 – (1/6)Q + 2I, where I is income and the supply function is P = (1/3)Q. Currently I = 25.
a. Find the current equilibrium price and quantity.
b. Suppose the government imposes a $5 per unit excise tax on the product (charged to the supplier). Find the new equilibrium price and quantity.
c. Draw a graph that shows the equilibriums before and after the tax. Show the areas of the graph that represent the tax borne by consumers and the tax borne by suppliers (together they add up to the total tax collected). Also depict the deadweight loss imposed by the tax.
d. Explain in words what the deadweight loss represents.
e. What happens if the $5 per unit tax is imposed on consumers rather than suppliers?
