Question

The U.S. government would like to help the Americar auto industry compete against foreign automaker: that sell trucks in the United States. It can do this by imposing an excise tax on each foreign truck sold in the United States. The hypothetical pre-tax demand anc supply schedules for imported trucks are given in the accompanying table. a. In the absence of government interference, what is the equilibrium price of an imported truck? The equilibrium quantity? Illustrate with a diagram. b. Assume that the government imposes an excise tax of \(\$ 3,000\) per imported truck. Illustrate the effect of this excise tax in your diagram from part a. How many imported trucks are now purchased and at what price? How much does the foreign automaker receive per truck? c. Calculate the government revenue raised by the excise tax in part b. Illustrate it on your diagram. d. How does the excise tax on imported trucks benefit American automakers? Whom does it hurt? How does inefficiency arise from this government policy?

Short answer

#Answer# a. The equilibrium price and quantity for imported trucks in the absence of government interference are found where the supply and demand curves intersect. This equilibrium point (P*, Q*) can be illustrated on a diagram with price on the vertical axis and quantity on the horizontal axis. b. The excise tax of $3,000 on each imported truck causes the supply curve to shift upwards by $3,000. The new equilibrium point (P', Q') is determined where the new supply curve intersects the demand curve. The price paid by consumers (P'_C) is equal to P', while the price received by foreign automakers (P'_F) is P' - $3,000. c. Government revenue generated by the excise tax is calculated as $3,000 * Q', and it can be represented on the diagram as a rectangle with a base extending from Q* to Q' and a height of the $3,000 excise tax. d. The excise tax on imported trucks benefits American automakers by making foreign trucks more expensive and potentially increasing the demand for domestic trucks. However, it hurts foreign automakers and consumers who must pay higher prices for imported trucks. The inefficiency from this policy leads to a potential deadweight loss, which can be represented on the diagram as a triangle with the tax wedge, having a height of the tax amount and a base being the difference between Q* and Q'.

Step-by-step solution

Find the equilibrium price and quantity

To find the equilibrium price and quantity, we need to find the price level at which the quantity demanded (from the demand schedule) is equal to the quantity supplied (from the supply schedule). Then, the equilibrium price is P* (with P* being the price where the two curves intersect), and the equilibrium quantity is Q* (with Q* being the number of imported trucks at that intersection).

Illustrate the equilibrium with a diagram

On the diagram, plot the demand curve and the supply curve, with the price on the vertical axis and the quantity on the horizontal axis. The point where the two curves intersect represents the equilibrium (P*, Q*). Label this point on the diagram. b.

Analyze the effect of the excise tax and find the new equilibrium

The imposition of a \(3,000 excise tax on each imported truck will lead to a vertical shift upward of the supply curve, since the cost of each truck increases by \)3,000. Find the new equilibrium point by looking for where the new supply curve intersects the demand curve. This point represents the new equilibrium price (P') and quantity (Q').

Calculate the price paid by consumers and price received by foreign automakers

The price paid by consumers (P'_C) will be the new equilibrium price (P'). The price received by the foreign automakers (P'_F) will be P' - $3,000, since the automakers receive the consumer price minus the excise tax.

Illustrate the effect of the excise tax on the diagram from part a

On the diagram from part a, draw the new supply curve shifted upwards by $3,000. Label the new equilibrium point (P', Q') where this new supply curve intersects the demand curve. c.

Calculate government revenue

Government revenue from the excise tax can be calculated as: Revenue = tax per truck * quantity of imported trucks sold = $3,000 * Q'.

Illustrate government revenue on the diagram

On the diagram, government revenue is represented as a rectangle, with the base extending from Q* to Q' on the horizontal axis, and the height being the 3,000$ excise tax. Shade this rectangle in. d.

Discuss the benefits, losers, and inefficiency

The excise tax on imported trucks benefits American automakers by making foreign trucks more expensive, which may lead to higher demand for domestic trucks. The policy hurts foreign automakers and consumers who must pay higher prices for imported trucks. Inefficiency arises since resources may not be allocated optimally, leading to a potential deadweight loss, which can be represented as a triangle on the diagram containing the tax wedge, where the height is the tax amount and the base is the difference of Q* and Q'.

Key concepts

Equilibrium Price

In an unregulated market, the equilibrium price is where the demand and supply curves intersect, meaning the quantity demanded equals the quantity supplied. This balance ensures that the maximum number of consumers are satisfied without creating excess supply or unmet demand.

To find this point, one examines demand and supply schedules to determine where they match perfectly. In our scenario with imported trucks, the equilibrium price (denoted as \(P^*\)) is the cost at which no surplus or shortage exists, and the equilibrium quantity (denoted as \(Q^*\)) is the number of trucks exchanged at this price.

A graph typically helps visualize equilibrium by plotting price on the vertical axis and quantity on the horizontal axis. The intersection of the demand curve (downward sloping) and supply curve (upward sloping) marks the equilibrium point \((P^*, Q^*)\). Calculating this is critical because it sets the baseline for understanding changes in the market due to interventions, like excise taxes.

Government Revenue

When an excise tax is applied, it creates a new source of revenue for the government by charging a fixed amount per unit sold. This tax does not just generate income but also acts as a tool to influence market behaviors.

In the context of trucks, if the government imposes an excise tax of \($3,000\) per truck, the supply curve shifts upwards by this amount. The new intersection with the demand curve establishes the post-tax equilibrium price and quantity, \(P'\) and \(Q'\), respectively.
The tax revenue generated is a straightforward calculation:

• Tax Revenue Formula: \( \text{Revenue} = \text{tax per unit} \times \text{quantity sold} = 3,000 \times Q' \)

This area is represented graphically as a rectangle, extending along the quantity axis from \(Q^*\) to \(Q'\) and vertically to the tax amount. The government earns this revenue, impacting both the market balance and participants significantly.

Deadweight Loss

Deadweight loss refers to the lost economic efficiency when the equilibrium outcome is not achieved due to market distortions, like an excise tax.

The introduction of a tax causes the price buyers pay to rise and the price sellers receive to fall, disrupting the original equilibrium \((P^*, Q^*)\). Consumers and producers face this new market condition at \(P'\) and \(Q'\).
However, because the tax raises prices, not all potential trades happen – the quantity of trucks purchased decreases from \(Q^*\) to \(Q'\) – resulting in unmet demand and unutilized supply potential. This inefficiency manifests as a deadweight loss, often depicted as a triangle on the graph:

• Height: The tax amount \(3,000\)
• Base: The difference in quantity from \(Q^*\) to \(Q'\)

The existence of deadweight loss illustrates essential trade-offs in policymaking, as it shows the cost of raising revenue and protecting specific industries through tariffs or taxes. Recognizing this helps in assessing whether the benefits, such as industry protection, outweigh the economic costs.