Question

Suppose that the federal government decides to increase the excise tax on cellular phone services by 0.1 percent. Why will this action cause the equilibrium price of cellular phone services to rise?

Short answer

The increase in excise tax decreases supply, causing the equilibrium price to rise.

Step-by-step solution

Understanding Excise Tax

An excise tax is a specific tax levied on the sale of a particular good or service. In this scenario, the federal government is increasing this tax by 0.1% on cellular phone services. This means that for every unit of cellular phone service sold, the service provider has to pay an additional 0.1% of the price to the government.

Effect on Supply Curve

When the excise tax is increased, the cost of providing cellular phone services rises for the suppliers (cellular service providers). This is because a portion of their revenue is now being paid as tax, effectively reducing their take-home profit. This situation causes the supply curve to shift to the left because suppliers will supply less at each price point than they previously did.

Adjustment to New Equilibrium

With the supply curve shifting to the left, there is now less quantity supplied at any given price, creating a shortage at the initial equilibrium price. To alleviate this shortage, the price must rise to reestablish equilibrium where the quantity demanded equals the quantity supplied.

Conclusion on Equilibrium Price

As a result of the leftward shift in the supply curve, the new equilibrium occurs at a higher price level than the original. Thus, the increase in the excise tax causes the equilibrium price of cellular phone services to rise.

Key concepts

Equilibrium Price

The equilibrium price is the point where the supply and demand curves intersect, indicating an agreement between buyers and sellers on the price and quantity of a good or service. Imagine you have a market where both sellers and buyers interact freely. Sellers want to charge as much as possible, while buyers aim to pay as little as they can. The equilibrium price is essentially where both parties are satisfied—a point of balance in the market.
When the supply curve shifts, it alters that balance. With an increased excise tax on cellular phone services, supply decreases, and the equilibrium price naturally moves up. As there's less supply, consumers are willing to pay more to get the same service, pushing the price higher until a new equilibrium is reached.

Supply Curve

The supply curve graphically represents the relationship between the price of a product and the quantity of the product that a seller is willing to supply. It's typically upward sloping, meaning that as prices increase, sellers are more motivated to supply more of the product.
When the government imposes an excise tax, the supply curve shifts to the left. This shift signifies that for any given price, suppliers are now offering less of the service due to the increased cost of taxation. In essence, service providers are not as incentivized to offer their usual quantity because a portion of their revenue is now going to taxes.
To visualize this: suppose a provider was previously willing to supply 100 units at a price of $50. With the tax, they might only supply 80 units at the same price. This creates a decrease in available services at each price point, raising the equilibrium price.

Cellular Phone Services

Cellular phone services are essential for communication and have a unique market behavior because they are widely needed and used by consumers. These services fall under the telecommunication sector, which includes other services like internet and cable.
Given their necessity, changes in the market dynamics, such as an increase in excise tax, can greatly affect pricing and availability. Service providers, facing higher costs due to the tax, must decide how much of the additional cost they can pass onto consumers.

• If providers pass all the costs to consumers, users may see a jump in their bills but not necessarily a decrease in usage due to the essential nature of these services.
• If they absorb some costs, there might be less impact on prices but potentially at the cost of lower profit margins or reduced investment in services.

This makes understanding how excise taxes influence such a critical industry vital for consumers and policymakers alike. Indeed, any governmental decision that alters the costs of such foundational services needs careful consideration due to its broader economic and social implications.