Question

Suppose that before tax was imposed 400 million gallons of gasoline was supplied at $3.00 per gallon.

a. What happens when government imposes a tax of 60 cents per gallon on sellers?
b. How would such a tax affect the market for gasoline i.e. what is the new equilibrium?
c. On whom does the incidence of the tax fall more heavily?
d. How much government revenue will be generated by the excise tax?
e. What happens when government imposes a tax of 60 cents per gallon on buyers?
f. How would such a tax affect the market for gasoline i.e. what is the new equilibrium?

Answer 1

When the government imposes a tax of 60 cents per gallon on sellers, the price of gasoline for buyers increases to $3.60 per gallon and the quantity supplied decreases. The incidence of the tax falls more heavily on the buyers, and the government revenue generated by the excise tax can be calculated by multiplying the tax per gallon by the quantity of gasoline sold. When the tax is imposed on buyers instead of sellers, the price of gasoline for sellers remains the same but the quantity demanded and the equilibrium price both decrease.

Step-by-step explanation:

a. When the government imposes a tax of 60 cents per gallon on sellers, the price of gasoline for buyers increases by 60 cents. This means that the price they pay per gallon will be $3.00 + $0.60 = $3.60 per gallon. Sellers will still receive $3.00 per gallon, but will have to pay the 60 cents per gallon tax to the government.

b. The new equilibrium in the market for gasoline will be at a higher price and a lower quantity. The price will increase to $3.60 per gallon and the quantity supplied will decrease to a new level. The quantity demanded will also decrease to a new level, but the decrease may not be as large as the decrease in quantity supplied.

c. The incidence of the tax falls more heavily on the buyers of gasoline. They are the ones who have to pay the higher price of $3.60 per gallon, even though the sellers are the ones who have to physically pay the tax to the government.

d. The government revenue generated by the excise tax can be calculated by multiplying the tax per gallon ($0.60) by the quantity of gasoline sold. If we assume that the new equilibrium quantity is 350 million gallons, then the government revenue from the tax would be $0.60 * 350 million gallons = $210 million.

e. When the government imposes a tax of 60 cents per gallon on buyers, the price of gasoline for sellers remains the same at $3.00 per gallon. However, buyers now have to pay an additional 60 cents per gallon as a tax on top of the price they are already paying.

f. The new equilibrium in the market for gasoline, when a tax of 60 cents per gallon is imposed on buyers, will be at a lower price and a lower quantity. The price will decrease to a new level and the quantity demanded will also decrease to a new level.