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15.3: Effect of Taxes
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- How does a monopoly respond to taxes?
- A perfectly competitive industry must pass on all of a tax to consumers because, in the long run, the competitive industry earns zero profits. A monopolist might absorb some portion of a tax even in the long run.
- A tax causes a monopoly to increase its price and reduce its quantity.
- A tax may or may not increase the monopoly markup.
- Use a revealed preference argument to show that a per-unit tax imposed on a monopoly causes the quantity to fall. That is, hypothesize quantities qb before the tax and qa after the tax, and show that two facts—the before-tax monopoly preferred qb to qa, and the taxed monopoly made higher profits from qb—together imply that qb ≤ qa.
- When both demand and supply have constant elasticity, use the results of 0 to compute the effect of a proportional tax (i.e., a portion of the price paid to the government).