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Question 1
Assume the government wishes to reduce alcohol consumption by considering a higher excise tax on alcohol products. Collect information on estimates for the price elasticity of demand for alcohol products. Based on these elasticity estimates illustrate using a demand/supply diagram(s) who bears the burden of the higher excise tax, consumers or producers.
As an alternative for reducing alcohol consumption assume the government is also considering the imposition of a minimum price on alcohol products. Using a demand/supply diagram illustrate the consequences of imposing a minimum price on alcohol for the consumption of alcohol products.
Provide comment on the relative merits of increasing excise taxes compared to imposing a minimum price on alcohol products for reducing alcohol consumption.
Question 2
a) Assume that in long-run equilibrium the minimum point of the LRAC curve for a table manufacturer's tables in $200 per table. Under conditions of monopolistic competition, will the long-run price of a table be above $200, equal to $200 or less than $200. Explain your answer.
b) What are of the characteristics of an oligopolistic market? Give three examples of industries with oligopolistic firms in Australia. Justify your examples by relating them to the characteristics of oligopolistic firms.
c) What are the characteristics of a monopolistically competitive market? Give three examples of industries with monopolistically competitive firms in Australia. Justify your examples by relating them to the characteristics of monopolistically competitive firms.
d) Assume that two firms make up a natural duopoly. What are the conditions which may make this occur? Sketch the market demand curve and cost curves that describe the situation in this market and that prevent other firms from entering.
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Answer 1: An indirect tax, when imposed, can be passed on to consumers or the sellers as per the circumstances. In the case of alcohol, it is not a necessary substance but an addictive substance. As a result, the demand will be inelastic, and the taxes will be passed majorly to the consumers in the form of higher prices (Khurana & Sharma, 2016). The way in which an imposed tax is divided between the consumers and sellers is known as tax incidence.
The elasticity of demand and supply can be examined to see who bear most of the tax burden. In the case of alcohol, the demand inelasticity is more than the supply elasticity (Ilaboya & Mgbame, 2013). This makes consumers bear most of the burden of the imposed tax. Whenever a demand is more inelastic, the quantity demanded does not change much with the price of the product. This means that even after the tax is introduced, the quantity demanded will remain relatively the same. The government can easily impose an indirect tax (excise tax) without affecting the equilibrium price.
Supply is more elastic, and hence the quantity supplied is more responsive to the price changes (Anushuya & Pal, 2014). The price difference between the equilibrium price and the new price paid by the consumers and the sellers is disproportionately divided. The increase in the price paid by the consumers (Pc-Pe) is more than the increase in the price paid by the sellers (Pe-Pp). The total difference in the price (Pc-Pp) is now much greater than the equilibrium price Pe, where both paid an equal price. It can be concluded that in a market where supply is more elastic than demand, the sellers get profited, and the consumers pay the higher price in the form of tax (Burtraw & Zetterberg, 2013).
A price floor or minimum price is many times imposed by a government. It is the lowest price that can be legally paid by any consumer. The main purpose of this is to support the minimum price from falling below a particular level. The figure below can explain how this affects the consumption of alcohol.
In the absence of any price floor, the equilibrium price would be P, and the equilibrium quantity would be Q. Once the price floor is imposed, the equilibrium is disturbed. The price is set at PM and the quantity demanded is Q1 but the quantity supplied is Q2. The market equilibrium level is obtained with this new price and quantities. The result is an excess or surplus of the quantity supplied than quantity demanded. Here, the manufacturers benefit, and the consumers pay the difference in the new and the old price (Dragusanu & Nunn, 2013). The demand or the supply curve as a whole does not change by this. Only a new equilibrium is set along with the demand and the supply curve. Here, it should be understood that the main objective of imposing a minimum price is to encourage people to switch to other substitutes of alcohol like soft drinks. Many people, if not addicted, will actually switch, and the ultimate goal of the government will be met (Khurana & Sharma, 2016).
