Part I: Tax incidence
Given the demand and supply function of pizzas are
The equilibrium price and quantity in the Pizza market can be determined as
Now, the government imposes a tax of $3 tax for per units of pizza purchased. The tax altered the demand equation as
Given the new demand and existing supply function new equilibrium is
The equilibrium price represent the price received by the sellers. The buyers however paid a much higher price.
The old demand function
From this the inverse demand function can be obtained as
The price that buyers pay after tax is obtained as
Figure 1: Tax incidence in the Pizza market
The figure above can be used to understand the incidence of taxation. The downward sloping curve DD shows demand curve for pizza and SS curve shows the corresponding supply curve. As a result of $3 tax on per unit of pizza purchased, there is inward shift of the demand curve to D’D’ (Taylor et al. 2014). Now, the price paid by buyers increases to $8 from initial equilibrium price of $7. From the price paid by buyers, sellers receive only $5 and the rest goes to government. The equilibrium number of pizzas in the market declined to 4 from initial equilibrium of 6. Government receives a revenue of
($3*4) = $12. The burden to buyers is ($8 - $7) *4 = $4. The burden to seller is ($7 - $5) *4 = $8. The buyers bear a less burden of taxation as compared to seller because of the relatively elastic demand curve.
Part II: Price regulation
Figure 2: Effect of US farm bill on Equilibrium
The equilibrium in the wheat market is at E. The price is at $250 with an equilibrium quantity of 1000,000 tons of wheat. Under the Farm bill, price is set at $300, above the domestic equilibrium price of $250. At $300, the supplied quantity of wheat is 1200,000 tons while demanded quantity is 800,000 tons. In the market there exists a surplus of (1200,000 – 800,000) = 400,000 tons of wheat.
Figure 3: CS, PS and Deadweight loss
Under domestic equilibrium price of $250, the surplus to consumer is shown by the area of the triangle ABE. The surplus to producer is the triangular area of BEC. As the price now increases to $300, the consumer surplus now reduces to the triangle ADF. The new producer surplus is equivalent to area of the trapezium DFHC. Part of the consumer surplus transferred to producers. The dead weight loss is the area of the triangle EFH.
Under domestic equilibrium the consumer and producer surplus can be computed as
Total surplus is the sum of consumer and producer surplus
With farm bill, the change in consumer surplus, producer surplus and resulted deadweight loss can be calculated as
The notion of fairness in economics implies that the wealth that is take out of the system should be proportional to the contribution put into the system. Under any form of price intervention, there is not absolute transfer of welfare from one party to another. Like in case of US farm bill, price in the market artificially increases to $300. The buyers face a high price and hence experiences a reduction in surplus. However, the reduced surplus does not completely transfer to the farmers. The agricultural price support program results in a marketed surplus in the economy. The surplus needs to be purchased by government (Frank 2015). This additional burden of government budget is again fall on the buyers in form of a higher taxation. The surplus to farmers though increases but at the cost of other groups in the society. The fruits of price support program are not even fairly distributed among the farmers. Large farmers generally gain at the expense of small and medium sized farmers. The result of US farm bill is thus not fair.
Frank, R.H., 2015. Principles of microeconomics, brief edition. Mcgraw-Hill.
Taylor, T., Greenlaw, S.A., Dodge, E.R., Gamez, C., Jauregui, A., Keenan, D., MacDonald, D., Moledina, A., Richardson, C., Shapiro, D. and Sonenshine, R., 2014. Principles of microeconomics. OpenStax College, Rice University.