Question

In 1990 the United States began to levy a tax on sales of luxury cars. For simplicity, assume that the tax was an excise tax of $6000 per car. The accompanying figure shows hypothetical demand and supply curves for luxury cars. a. Under the tax, what is the price paid by consumers? What is the price received by producers? What is the government tax revenue from the excise tax? Over time, the tax on luxury automobiles was slowly phased out (and completely eliminated in 2002). Suppose that the excise tax falls from $6000 per car to $4500 per car.b. After the reduction in the excise tax from $6000 per car to $4500 per car, what is the price paid by consumers? What is the price received by producers? What is tax revenue now?c. Compare the tax revenue created by the taxes in parts a and b. What accounts for the change in tax revenue from the reduction in the excise tax?

Answer 1

The price consumers pay for luxury cars includes the initial equilibrium price plus the excise tax. Producers receive the initial price minus the tax incidence they bear. Tax revenue depends on the tax rate and the sold quantity, both of which are affected by the elasticity of demand and supply.

Step-by-step explanation:

Understanding Excise Tax on Luxury Cars

When an excise tax is levied, it creates a difference between the price paid by consumers (Pc) and the price received by producers (Pp). In the case of the luxury car tax, without actual figures, we can't precisely state the new prices, but we can say that the price paid by consumers will be the initial equilibrium price plus the tax, while the price received by producers will be the initial equilibrium price minus the share of the tax that producers bear. Tax revenue can be calculated by multiplying the tax per unit by the quantity sold (Qt).

Upon the reduction of the excise tax from $6000 to $4500, the price paid by consumers will decrease proportionally, so will the price received by producers increase, since they bear less of a burden. Government tax revenue will change as well. It could increase or decrease depending on the elasticity of demand and supply, as this dictates the change in quantity sold post-tax reduction.

The difference in tax revenue from the $6000 to the $4500 tax scenarios can be compared by looking at changes in quantity sold. If the demand is very elastic, the lower tax may lead to a significant increase in quantity sold, potentially increasing revenue despite the lower tax per unit. Conversely, inelastic demand would mean little change in quantity, potentially reducing revenue.