What is the equilibrium quantity of a market with a demand curve P = 10 - Q and a supply curve equal to P = 2 + 2Q and a tax imposed on the seller of $2 per unit? How does this tax effect resource allocation? What might justify the allocation effect of the tax?
What will be an ideal response?
Quantity = 2 because 10 - Q = 4 + 2Q, or 3Q = 6, so Q = 2. Before the tax the equilibrium was 2.67 units of output. Thus the tax reduces output. If the producer was discharging pollution equal to $2 per unit of output, then the optimal output would be 2 and the tax would be pushing the allocation process toward efficiency rather than away from efficiency.
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