Relate to the following scenario: Imagine a good is currently taxed at a rate of 30% of its price. Assume there are no externalities for this good. The good is created from an intellectual property patent. To support producers of the good, the government is proposing to reduce the tax rate to 17%. 

(a) Show the effects (directions of change) that the proposed reduction in the tax has on price and quantity in a competitive market. Ensure you start your analysis from a situation where the larger (30%) tax is already in place. [5 marks] 

(1b) [graph] Using a properly labelled version of the graph from question (1a) (or a new graph if that is easier) show the welfare effects of the proposed reduction in the tax. Ensure you consider the welfare changes of the individual parties involved, as well as society as a whole. Conclude by providing clear intuition (i.e., without referring to technical features from the graph) as to why this overall change in society's welfare occurs. [5 marks] 

(1c) [graph] Consider instead a scenario where the good in question begins with no tax at all. The government wishes to support producers of the good and introduces a binding price floor. Show the effects of this price floor on a graph and compare it to the graph in part (1a). Are the effects (directions of change) of a price floor on price and quantity any different to the case of a reduction in tax? [5 marks]

(1d) Will the amount of tax revenue collected by the government increase or decrease because of the proposed tax reduction? Discuss about the concept of elasticity. [4 marks]

Answer rating: 100% (QA)

a When the tax rate on the good is reduced from 30 to 17 it will lead to a decrease in the price paid by consumers and an increase in the quantity of ... View the full answer